When you rebalance, you’re managing the proportions of stocks, bonds, and other assets in your portfolio for the long run. Rebalancing helps control risk and keeps your investment plan on course.
However, rebalancing requires some forethought, so don’t jump right into it. Before making a change to your portfolio, keep in mind these 3 best practices:
- Manage risk. Emotions tend to run high because rebalancing often involves taking money from a portfolio’s best-performing assets and moving it to poorer performers. Remember: The goal of rebalancing is to keep your risk exposure at a level that’s comfortable for you; maximizing returns should not be the focus.
- Set a rebalancing “trigger.” There’s more than one right way to rebalance. It can be according to a set time interval (quarterly or annually, for example) or when your portfolio’s asset allocation differs from your target by a certain percentage. Committing to a rebalancing strategy is more important than the actual strategy you choose. Simply having a strategy generally provides greater risk-adjusted returns than neglecting to rebalance.
- Minimize potential costs. Rebalancing by selling or exchanging shares in a taxable account can result in capital gains, which may be subject to capital gains tax. Explore all your options before you commit to a transaction with tax consequences.
Tax-efficient rebalancing techniques
If you invest in a taxable (i.e., nonretirement) account and sell investments that have gained value, you’ll most likely owe taxes. The following tips can help you manage potential taxes as you realign your current asset mix with your target.
- Rebalance within tax-advantaged accounts. Selling shares of an overweight asset class to buy shares of an underweight asset class in a tax-advantaged account (such as an IRA) isn’t a taxable event.
- Avoid selling assets in taxable accounts. Instead, direct new investments to the underweight asset class, or reinvest dividends and capital gains in a different asset class to realign your portfolio.
- Use your required minimum distribution (RMD). An RMD is an unavoidable taxable event, so consider it a rebalancing opportunity. Take your distribution from an overweight asset class. If you’re philanthropically inclined, donate the proceeds through a qualified charitable distribution to avoid paying taxes on that amount.
- Take advantage of tax-loss harvesting.* This strategy involves intentionally selling investments at a loss to balance capital gains with capital losses—minimizing your taxes.
Commit to rebalancing
Don’t lose sleep over whether you’ve chosen the right rebalancing strategy. The most important thing is to rebalance regularly. (Not convinced? Read our research.)
If you’re not ready to commit to rebalancing regularly, consider other options. Partner with a financial advisor to lessen the burden of rebalancing, or invest in an all-in-one fund that automatically rebalances for you.
*Tax-loss harvesting involves certain risks, including, among others, the risk that the new investment could perform worse than the original investment, and that transaction costs could offset the tax benefit. There may also be unintended tax implications. We recommend that you consult a tax advisor before taking action.
All investing is subject to risk, including the possible loss of the money you invest.
Be aware that fluctuations in the financial markets and other factors may cause declines in the value of your account.
There is no guarantee that any particular asset allocation or mix of funds will meet your investment objectives or provide you with a given level of income.
Past performance is no guarantee of future returns.
Advice services are provided by Vanguard Advisers, Inc., a registered investment advisor, or by Vanguard National Trust Company, a federally chartered, limited-purpose trust company.