How to Rebalance Your Portfolio Before 2026

Key Concepts

• Rebalancing: Periodically adjusting a portfolio’s asset allocation to maintain the desired risk level.
• Asset Allocation: The strategic distribution of investments across different asset classes (stocks, bonds, cash, etc.).
• Risk Reduction: The primary benefit of rebalancing, achieved by selling high-performing (potentially overvalued) assets and buying underperforming (potentially undervalued) assets.
• Tax-Advantaged Accounts: Retirement accounts (IRA, 401(k)) where investment gains are not taxed until withdrawal.
• Taxable Accounts: Investment accounts where gains are subject to current taxation.
• Equity Allocation: The percentage of a portfolio invested in stocks.
• Fixed Income: Investments that provide a return in the form of fixed periodic payments, such as bonds.
• Valuation: The process of determining the current worth of an asset.
• US Market Cap: The total value of all publicly traded companies in the United States.

Portfolio Rebalancing: A Detailed Guide for Investors

Introduction

As the year concludes, investors frequently evaluate and adjust their portfolios. This discussion, featuring Christine Benz, Director of Personal Finance and Retirement Planning at Morningstar and co-host of the Long View podcast, focuses on the key considerations for rebalancing. The core argument presented is that rebalancing is primarily a risk management strategy, not necessarily a return-enhancing one.

1. The Rationale for Rebalancing

The primary benefit of rebalancing lies in risk reduction. By systematically selling asset classes that have experienced strong performance (and are often highly valued) and reinvesting in those that have underperformed (and may have more attractive valuations), investors can maintain their desired risk profile. While some research explores potential return enhancements, the consensus is that risk reduction is the main driver for rebalancing.

2. Determining the Need for Rebalancing: Thresholds and Frameworks

Effective rebalancing begins with establishing a clear asset allocation framework – for example, 60% stocks, 30% bonds, and 10% cash. Crucially, investors should define acceptable variance thresholds from these targets. Christine Benz suggests thresholds of 5 to 10 percentage points as a practical guideline. For instance, if an equity allocation target is 60% and the actual allocation reaches 67%, rebalancing should be considered. This buffer allows for normal market fluctuations without triggering unnecessary transactions.

3. Age and Proximity to Retirement: A Critical Factor

An investor’s age and time horizon significantly influence the rebalancing approach. Risk reduction becomes increasingly important as retirement nears.

• Investors under 50: Can generally tolerate higher equity allocations due to their longer time horizon and potential for greater long-term returns.
• Investors over 50: Should prioritize increasing allocations to lower-risk assets, particularly as they approach retirement. This provides a “bucket” of assets to draw from if equity markets decline, preventing the need to sell equities during downturns.

4. Rebalancing Strategies by Age Group

• Under 50 (Saving for Retirement): Focus should be on maintaining a high equity allocation. Specific attention should be paid to international versus US equity allocation. Benz recommends a benchmark of approximately 65-67% US market cap and the remainder in non-US equities, noting that many investors are significantly underallocated to international stocks. Additionally, she suggests considering small-cap value stocks, which have historically underperformed large-cap growth stocks and may present a value opportunity.
• Over 50 (Approaching/In Retirement): Prioritize high-quality fixed income (US bonds) as a ballast against equity risk. Building a cash allocation is also crucial, especially within a few years of retirement, to create a readily available source of funds. However, excessive cash holdings beyond emergency reserves are discouraged for those still several years from retirement.

5. Tax Implications and Mitigation Strategies

Rebalancing can trigger capital gains taxes when selling appreciated assets in taxable accounts. To minimize tax consequences:

• Prioritize Rebalancing in Tax-Sheltered Accounts: Rebalance within IRAs or 401(k)s where gains are not taxed until withdrawal.
• Utilize New Contributions: In taxable accounts, use new contributions to increase allocations to underperforming asset classes.
• Tax-Loss Harvesting (Market Dependent): In certain market conditions, investors may be able to offset capital gains by selling losing investments. However, this was noted as less likely in the current market environment.

6. Global Market Allocation & Style Box Considerations

Benz highlights the importance of a diversified global portfolio. The US currently represents roughly 65-67% of the global market capitalization, and investors should aim for a similar allocation. She also points out the potential value in small-cap value stocks, which have lagged behind large-cap growth stocks.

7. The Role of High-Quality Bonds

Research consistently demonstrates that high-quality US bonds provide excellent diversification benefits for US equity portfolios. They act as a “ballast,” providing a source of funds during equity market downturns. Short and intermediate-term bonds are particularly suitable for investors nearing retirement.

Notable Quote:

“Risk reduction is really the main reason to consider rebalancing.” – Christine Benz

Conclusion

Effective portfolio rebalancing is a disciplined process centered on risk management. By establishing clear asset allocation targets, defining acceptable variance thresholds, and considering age and time horizon, investors can proactively manage their portfolios and navigate market fluctuations. Prioritizing tax-advantaged accounts and utilizing strategic contribution methods can further enhance the effectiveness of rebalancing efforts. The key takeaway is that rebalancing isn’t about chasing returns; it’s about maintaining a portfolio aligned with your risk tolerance and financial goals.