Rebalancing Your Portfolio – When, Why, and How to Do It Right

In Episode 20, we dive into portfolio rebalancing - one of the most overlooked yet effective tools for long-term investors. You'll learn how rebalancing helps manage risk, enforce discipline, and systematically implement buy-low/sell-high behavior. We break down different rebalancing strategies - time-based, threshold-based, and hybrid - and explain how to handle taxes and costs in both taxable and retirement accounts. Real-world examples show how rebalancing keeps your portfolio aligned with your goals, without relying on market timing. If you want to invest smarter with less emotion, this episode gives you a simple system that works.

Episode Transcript

Speaker 1 (00:00):
As always before we begin, this podcast is for informational
and educational purposes only. It is not financial advice. Always
do your own research and consult with a licensed advisor
before making any investment decisions. Welcome back to the Smarter
Money Show. I'm your host, and this is episode twenty.
Today we're talking about something that's rarely flashy, often overlooked,

(00:22):
and incredibly powerful over the long term. Portfolio rebalancing. Now,
if you're hearing that term and thinking that sounds boring,
you're not wrong. But here's the twist. Rebalancing is one
of the most effective ways to protect your portfolio, lock
in gains, and systematically do the hardest thing in investing,
buy low and sell high. And you can do it

(00:42):
without trying to time the market, without watching CNBC all day,
and without guessing what the Fed will do next. So
let's start with the basics. What is portfolio rebalancing. Rebalancing
is simply the process of adjusting your portfolio back to
its original or target allocation. Let's say your target is
sixty percent socks and forty percent bonds. Over time, if

(01:03):
stocks rise faster than bonds, that balance gets out of whack.
Maybe now, you're at seventy thirtieths. That means you're taking
on more risk than you intended. So you sell some
stocks and buy some bonds to return to sixty fortieths.
Simple idea, big implications, because here's what happens. When you
don't rebalance. You end up overexposed to whatever has been
doing well recently. You're riding high when markets are up,

(01:26):
but you get hit harder when they crash. That's not strategy.
That's drift, and drift is dangerous. Let's go deeper. Why
should you rebalance? Reason one risk control. Every portfolio has
a risk profile. If you build a sixty fortieth portfolio,
you've set that base on your goals, your time horizon,
and your comfort level. When the market moves, your exposure shifts,

(01:48):
often without you realizing it. Rebalancing brings you back in line.
It keeps your risk consistent even as the world changes
around you. Reason two discipline. Rebalancing forces you to do
what's emotionally hard. Sell what's been going up and buy
what's been lagging. That's counterintuitive. Most people chase winners. Rebalancing
flips that. It's a rules based way to sell high

(02:09):
and buy low. The core of long term investing success.
Reason three performance over time. Studies have shown that regular
rebalancing can improve long term returns, especially when markets are volatile.
It's not about outperforming every year. It's about compounding smarter
over decades. You're smoothing out your ride and letting time
work in your favor. Reason four removes emotion. Rebalancing gives

(02:31):
you something Most investors never have a system. No more,
should I sell or is this the top? You just
follow the plan. When the numbers hit your thresholds, you act.
It's mechanical. That's what makes it effective. Now let's talk
about how to rebalance. There are three main approaches. Time
based rebalancing. This is where you rebalance on a fixed

(02:52):
schedule once a year, twice a year, quarterly, whatever you choose. Simple, predictable,
and easy to automate. People go with annual or semi
annual rebalancing, and that's perfectly fine. Threshold base rebalancing. Instead
of checking the calendar, you rebalance when your allocations drift
beyond a certain percentage. For example, if your target is

(03:12):
sixty forty s and stocks go up to sixty five percent,
that's a five percent drift, So you rebalance. This method
is more dynamic and reacts to actual market movement, but
it requires more monitoring. Hybrid approach some investors combine the two.
They check once a quarter, and if any position is
more than, say, five percent off target, they rebalance. Otherwise

(03:33):
they leave it alone. This balance is disciplined with efficiency,
so which one is best? Honestly, the best strategy is
the one you'll actually stick with. Consistency beats perfection, whether
you rebalance every six months or when threshold's hit. The
key is having a rule and following it. Now, let's
talk about costs and taxes, because rebalancing isn't free. Every

(03:53):
time you sell something, you may trigger capital gains taxes,
especially in taxable accounts, and if you're rebalancing two frequently,
you might be giving away part of your return. That's
why tax advantage accounts like iras or four hundred and
one k's are ideal for rebalancing. No taxes until withdrawal.
In taxable accounts, consider these tips. Rebalance with new contributions

(04:16):
if possible. Instead of selling, just redirect your cash into
underweight assets. Use dividends to rebalance. Be mindful of short
term gains. Wait twelve months if possible, to benefit from
long term capital gains, rates harvest losses to offset gains
if available. You don't need to rebalance every month. In fact,
doing it too often can reduce returns. Most studies suggest

(04:36):
that rebalancing once or twice a year gives a sweet
spot between discipline and efficiency. Now let's talk about what
to rebalance. You can rebalance at different levels. At the
asset class level, stocks versus bonds versus cash, at the
regional level, us versus international versus emerging markets, at the
style level, growth versus value, small versus large cap, even

(04:58):
at the sector or ETF level. If your portfolio is
more complex, how deep you go depends on how hands
on you want to be. For most people, keeping it simple,
a few core ETFs with fixed target weights is more
than enough. Let's look at a real world example. Say
you've got one hundred thousand dollars in a sixty forty
itth portfolio, sixty thousand dollars in a total stock market

(05:20):
ETF like VTI, forty thousand dollars in a bond ETF
like B and D. Now the stock market has a
strong year and your stock ETF grows to seventy five
thousand dollars while your bonds stay flat. Your portfolio is
now sixty five thirty fifths. You're taking more risk than intended.
Rebalancing means selling seven five hundred dollars of VTI and

(05:42):
moving it into B and D to return to sixty fortieths.
You just locked in some gains, reduced your risk, and
brought the portfolio back in balance, all without guessing what
happens next. You can also rebalance within asset classes. For example,
say your international equity exposure has underperformed for two years. Now,
it's underweight in your portfolio. Rebalancing gives you a reason

(06:03):
to allocate more, even if your gut says no, that's
the point. It's not emotional, it's math. One underrated benefit
of rebalancing is reducing regret. When markets crash, most people panic.
But if you've been regularly trimming gains and reallocating into
underperforming areas, you've already built in protection. You've taken chips
off the table. That's not luck, that's process. Automated tools

(06:25):
can help here. Many robo advisors rebalance for you behind
the scenes. Some brokers let you set rebalancing reminders. Or
even build target allocations, use them, build a system you
don't have to micromanage. Let me leave you with this.
The goal isn't to predict, it's to stay aligned. Rebalancing
doesn't promise higher returns every year, but it gives you structure, discipline,

(06:47):
and long term resilience. And just to be clear, this
is not financial advice. This podcast is for informational and
educational purposes only. Always do your own research and consult
with a licensed advisor before me making investment decisions. If
you got value from this episode, follow the show, leave
a quick review and send it to someone who's never

(07:07):
rebalanced their portfolio. They probably need it. In the next episode,
we'll dive into market corrections and crashes, how to mentally
and financially prepare for the next big drop, and why
downturns are where real money is made. Until then, stay smart,
stay patient, and stay invested.