How to Rebalance Your Investment Portfolio

What Is Rebalancing and Why Does It Matter?

Rebalancing is the process of restoring your portfolio's asset allocation to your original target percentages after market movements have caused it to drift. If you started with a portfolio of 80 per cent equities and 20 per cent bonds, and equities outperform bonds over the following year, you might end up with 85 per cent equities and 15 per cent bonds. Your portfolio has drifted towards a higher risk profile than you intended. Rebalancing corrects this by selling some of the overweight asset and buying the underweight one.

Why Markets Cause Drift

Different assets grow at different rates and by different amounts in any given period. Equities might rise 20 per cent in a strong year while bonds return 2 per cent. Conversely, in a market crash equities might fall 30 per cent while bonds rise 5 per cent. Over time, these divergent returns cause your original allocation to shift significantly. Without rebalancing, a portfolio intended to be 80/20 equities to bonds might gradually become 90/10 or even 95/5 after years of strong equity performance — leaving you with more equity risk than you bargained for.

The Mechanics of Rebalancing

There are two main approaches to rebalancing. Sell and buy rebalancing involves selling the overweight asset class and using the proceeds to buy more of the underweight asset class, restoring the target allocation. Contribution-based rebalancing involves directing new investment contributions towards the underweight asset class rather than selling anything. The second approach is generally preferable for investors who are still in the accumulation phase — making regular contributions — because it avoids triggering capital gains tax events and is simpler to execute.

When Should You Rebalance?

Two common approaches exist for timing rebalancing. Calendar rebalancing involves rebalancing at a set frequency — annually, semi-annually, or quarterly — regardless of how far the allocation has drifted. Annual rebalancing is the most common and generally sufficient for most investors. Threshold rebalancing involves rebalancing whenever any asset class drifts more than a set percentage from its target — for example, rebalancing when equities move more than 5 percentage points above or below their target weight. Research suggests that either approach works well, with threshold rebalancing sometimes providing a slight advantage by responding more quickly to large market moves.

Rebalancing Within an ISA

One of the great advantages of rebalancing within a Stocks and Shares ISA is that it has no tax consequences. You can sell an overweight fund and buy an underweight fund without triggering any Capital Gains Tax liability. This makes rebalancing much more straightforward and cost-free for ISA holders. Outside an ISA, selling appreciated investments triggers potential CGT on gains above the annual allowance — a cost that can make rebalancing expensive for taxable accounts.

Automatic Rebalancing Options

For investors who prefer a hands-off approach, several options automatically rebalance portfolios. Vanguard LifeStrategy funds maintain their target equity-bond split automatically — the fund manager rebalances internally without any action required from the investor. Robo-advisers like Nutmeg, Moneyfarm, and Wealthify rebalance their managed portfolios automatically within their fee structure. Trading 212's Pie investing feature can rebalance automatically towards target weightings when new contributions are made.

Keeping Rebalancing Costs in Mind

On platforms that charge per trade, rebalancing too frequently adds unnecessary dealing costs. On platforms with no dealing fees — InvestEngine, Trading 212 — this is less of a concern. Platforms with percentage-based platform fees but no dealing fees make contribution-based rebalancing particularly attractive: simply direct new money to the underweight asset without selling anything. The goal is to maintain your target allocation with the minimum friction, cost, and tax impact.