Contents [Hide]

About

We previously introduced the U.S. Financial Independence Roadmap, How Much Money Do You Actually Need for Financial Freedom?, and also how to choose among common ETFs like VOO, VTI, QQQ, VT, and SGOV.

After reading those articles, many readers run into a very practical next question:

  • I bought the investments, but what should I do next?

For example:

  • If you originally planned for 80% stocks and 20% short-term bonds, but stocks rose so much that the portfolio is now 90% stocks, should you sell some?
  • If stocks fall in a bear market and an 80/20 portfolio becomes 65/35, should you buy more stocks?
  • If VOO and VTI have risen too much, should you switch into SGOV?
  • Is there any difference between rebalancing inside a 401(k), IRA, HSA, or a Taxable Brokerage account?
  • Will selling in a regular brokerage account trigger taxes?

This article explains a very important concept in long-term investing that many beginners overlook: rebalancing.

Simply put, rebalancing is not about predicting the market, and it is not about trying to buy low and sell high. It is about keeping your portfolio from drifting away from its original risk level.

Key points

  • Rebalancing means adjusting a portfolio back to its original target asset allocation.
  • Its main purpose is not to increase short-term returns, but to control risk.
  • When stocks rise a lot, the portfolio becomes more aggressive; when stocks fall a lot, the portfolio may become too conservative.
  • The two most common rebalancing methods are periodic rebalancing and threshold-based rebalancing.
  • Rebalancing inside a 401(k), IRA, or HSA is usually simpler, because trades inside those accounts generally do not create capital gains tax for the current year.
  • Rebalancing in a Taxable Brokerage account requires more caution, because selling appreciated assets may trigger capital gains tax.
  • For most households, the most practical approach is usually to rebalance first with new money, dividends, and payroll contributions, and avoid frequent selling in taxable accounts.
  • Target Date Funds, robo-advisors, and some all-in-one funds rebalance automatically, which is ideal for people who want a hands-off approach.

What is rebalancing, and why does it matter?

What does rebalancing mean?

Rebalancing means that when your portfolio drifts away from its original target allocation because of market gains and losses, you adjust it back to the target. Investor.gov gives a straightforward definition of rebalancing: it is bringing a portfolio back to its original asset allocation; because different investments rise and fall at different speeds, over time a portfolio may drift away from your investment goals.

Here is a simple example. Suppose you start with:

  • 80% VTI
  • 20% SGOV

If your total assets are $100,000, the initial allocation is:

  • VTI: $80,000
  • SGOV: $20,000

One year later, if U.S. stocks have risen a lot, the portfolio becomes:

  • VTI: $105,000
  • SGOV: $20,000
  • Total assets: $125,000

At that point, VTI’s share becomes:

$105,000 / $125,000 = 84%

Your portfolio has shifted from 80/20 to 84/16. That may not seem like a huge difference, but if stocks keep rising, it could become 90/10 or even 95/5. At that point, the amount of stock risk you are taking is already higher than what you originally planned.

Rebalancing is not predicting the market

I think one of the easiest things to misunderstand is assuming rebalancing means figuring out where the market is headed. It does not.

Rebalancing does not mean:

  • I think the stock market has topped out, so I’m selling stocks.
  • I think bonds are about to rise, so I’m buying bonds.
  • I think QQQ is too expensive, so I’m dumping it all.

Rebalancing is more like discipline:

  • I planned to take on a certain amount of risk, and I want to stay as close to that risk level as possible.

For example, if you originally chose 80% stocks because you believed you could tolerate that level of risk, then when the portfolio grows to 95% stocks, you are already taking more risk than planned. Rebalancing brings the portfolio back to plan instead of relying on gut feeling.

Why not just buy and hold and never touch it?

A pure buy and hold approach can absolutely work, especially for younger investors, people with strong risk tolerance, or portfolios that are very simple. The problem is that as the market rises and falls, the risk in your portfolio changes gradually too.

For example:

  • After stocks rise strongly for a long time, their percentage of the portfolio keeps increasing, so risk also increases.
  • After a major bear-market drop, stock allocation falls; if you do not buy back in, you may participate less in the rebound later.
  • If one sector, such as tech, has risen too much, your QQQ or individual-stock position may become increasingly concentrated.

The SEC’s beginner materials on asset allocation, diversification, and rebalancing also remind investors that asset allocation, diversification, and rebalancing are basic concepts for managing risk and keeping a portfolio balanced over the long run.

So the core benefits of rebalancing are:

  • Control risk.
  • Prevent the portfolio from drifting too far off course.
  • Force yourself not to chase only what has gone up.
  • Make the investment plan more actionable.

How do you rebalance?

Step 1: Decide on a target allocation first

The prerequisite for rebalancing is having a target allocation. If you do not have a target, there is nothing to drift away from.

Common target allocations include:

Target allocation Suitable for Characteristics
100% stocks Young investors, stable income, high risk tolerance High long-term growth potential, but high volatility
90% stocks / 10% cash or short-term bonds Young investors who still want a little cushion Still relatively aggressive
80% stocks / 20% bonds or short-term bonds Long- to medium-term investors A balance between growth and stability
70% stocks / 30% bonds or cash People approaching retirement, moderate risk tolerance Relatively less volatile
60% stocks / 40% bonds or cash People who value stability more A classic balanced portfolio, but with lower growth potential

The stock portion here can be:

  • VOO
  • VTI
  • VT
  • VTI + VXUS

The bond or short-term bond portion can be:

  • BND
  • AGG
  • SGOV
  • T-Bills
  • Money Market Fund

If you are just getting started, I do not think you need to make this too complicated. For example:

  • 100% VTI
  • 90% VTI + 10% SGOV
  • 80% VTI + 20% SGOV / BND
  • 100% VT

These kinds of portfolios are already simple enough.

Step 2: See how far it has drifted

Suppose your target allocation is:

  • 80% VTI
  • 20% SGOV

Now the portfolio has become:

  • 88% VTI
  • 12% SGOV

That means the stock portion is now 8 percentage points higher than your target.

At that point, you can choose to:

  • Sell part of VTI and buy SGOV.
  • Keep VTI, and direct future new money into SGOV.
  • Slowly bring the portfolio back with dividends or cash flow.

For most investors, I would suggest prioritizing the second and third approaches, especially in a Taxable Brokerage account.

Step 3: Choose a rebalancing method

There are two main common methods.

Method How it works Pros Cons
Periodic rebalancing Check once every six months or once a year Simple, low-maintenance, easy to follow May not act until the allocation has drifted a lot
Threshold-based rebalancing Only rebalance when the allocation deviates from target by a certain amount More disciplined, avoids frequent trading You need to review the portfolio regularly

For example, you could set it up like this:

  • Review it once at the end of every year.
  • If any asset class deviates from target by more than 5%, rebalance.
  • If the deviation is less than 5%, do nothing.

When Vanguard discusses target-date fund rebalancing, it also mentions threshold-based rebalancing, meaning adjusting only when the asset allocation drifts beyond a preset threshold, such as 1% or 2%; different strategies may rebalance back to target, move to a midpoint, or use other approaches.
Most households don’t need the same level of precision as a fund company. A simpler set of rules works fine:

  • Review once or twice a year.
  • Only act if the allocation drifts by more than 5%.
  • Use new money first to make adjustments.

That’s practical enough.

Step 4: Rebalance with new money first

Rebalancing doesn’t always mean selling. In many cases, a better approach is to adjust with new money.

For example, if your target is:

  • 80% VTI
  • 20% SGOV

but it has drifted to:

  • 85% VTI
  • 15% SGOV

then if you’re still investing every month, you can put the next few months of new money into SGOV until the allocation gradually moves back toward 80/20.

The advantages of this approach are:

  • You don’t have to sell appreciated assets.
  • In a taxable account, you can avoid triggering capital gains.
  • It’s psychologically easier to follow.
  • It works well for people still in the wealth-building stage.

So for someone who is still working and has monthly cash flow, the most practical way to rebalance is usually not “sell this and buy that,” but:

Put new money into the underweight asset.

How does rebalancing differ across account types?

401(k): usually the best place to rebalance

Rebalancing in a 401(k) is usually pretty convenient.

The reasons are:

  • Buying and selling funds inside the account generally doesn’t create capital gains tax in that year.
  • Many 401(k)s can be set up for automatic rebalancing.
  • You can also adjust the allocation through payroll contributions.
  • A Target Date Fund automatically adjusts and rebalances on its own.

If your 401(k) offers:

  • S&P 500 Index Fund
  • Total Market Index Fund
  • International Index Fund
  • Bond Fund
  • Stable Value Fund

then you can adjust the allocation directly inside the 401(k).

For example, if your target is:

  • 70% stock funds
  • 30% bonds / Stable Value Fund

and stocks rise to 80%, you can shift part of the stock funds into bond funds within the 401(k).

For most people, the 401(k) is one of the best places to handle rebalancing.

IRA / Roth IRA: also very suitable for rebalancing

An IRA and a Roth IRA are usually also well suited to rebalancing.

The reasons are similar:

  • Trades inside the account generally don’t create capital gains in that year.
  • You have more freedom in what you can invest in than in a 401(k).
  • You can directly buy ETFs such as VOO, VTI, VT, QQQ, and SGOV.

For example, if your Roth IRA is:

  • 80% VTI
  • 20% SGOV

and VTI has gone up too much, you can simply sell some VTI and buy SGOV inside the Roth IRA. That usually doesn’t create the same capital gains tax issue you’d have in a taxable brokerage account.

That said, I think the Roth IRA space is very valuable, so unless you’re close to retirement or have a low risk tolerance, many people would rather keep long-term growth assets in the Roth IRA instead of holding a large amount of SGOV there.

HSA: depends on whether you treat it as a short-term medical account or a long-term investment account

An HSA is a bit special.

  • If you use your HSA as a short-term medical spending account, then it makes sense to keep more cash, money market, or SGOV-type tools in it.
  • If you treat your HSA as a long-term investment account, and you pay medical expenses out of pocket while saving the receipts, then the HSA can lean more toward stock ETFs such as VTI, VOO, and VT.

So when rebalancing an HSA, the first question is:

  • Will you need this money for medical care in the next few years?

If yes, don’t put everything in stocks. If not, and your cash flow is strong enough, the HSA can be more aggressive.

A common approach is:

  • Keep 1–2 years of expected medical expenses in cash or short-duration bonds.
  • Invest the rest long term in stock index funds.
  • Check the allocation once a year.

If your HSA is with Fidelity, investment choices are usually more flexible; if it’s a company-sponsored HSA such as HealthEquity, Optum, or HSA Bank, the investment menu may be more limited.

Taxable Brokerage: the most flexible, but also the most tax-complicated

A regular brokerage account is the most flexible, but it’s also the one where you need to be most careful when rebalancing.

Because in a taxable brokerage account:

  • Selling appreciated ETFs may trigger capital gains tax.
  • Selling assets held for less than a year may result in short-term capital gains.
  • Frequent rebalancing can add tax and recordkeeping costs.
  • Distributions from SGOV, money market funds, and bond ETFs may also create tax consequences in the current year.

So for rebalancing in a taxable account, I’d suggest the following priority order:

  1. Use new money to buy the underweight asset.
  2. Use dividends and interest to buy the underweight asset.
  3. If you have losing positions, combine that with tax-loss harvesting.
  4. Only then consider selling a large appreciated position.

The SEC’s year-end investor bulletin also reminds investors that rebalancing means adjusting a portfolio back to its target asset allocation, because some investments may grow faster and cause the portfolio to become overly concentrated in certain asset classes. But in a regular taxable account, you also have to consider the tax cost.

Simply put:

  • Rebalancing is more flexible in retirement accounts; in taxable accounts, you need to use it more sparingly.

How do you rebalance some common portfolios?

Example 1: 100% VTI — do you need to rebalance?

If your portfolio is just:

  • 100% VTI

then strictly speaking, there is no rebalancing issue between stocks and bonds.

What you should do is:

  • Keep investing regularly.
  • Don’t keep switching positions because of short-term price moves.
  • As your age and risk tolerance change, decide later whether to add bonds or SGOV.

But if your account holds multiple similar ETFs, such as:

  • VOO
  • VTI
  • SCHB
  • ITOT

then rebalancing doesn’t add much value because they overlap heavily. What you really need to do is simplify the portfolio.

Example 2: 80% VTI + 20% SGOV

This is a simple stock + short-bond portfolio.

Target:

  • 80% long-term growth
  • 20% cash / short-bond buffer

Assume your starting assets are $100,000:

Asset Target allocation Initial amount
VTI 80% $80,000
SGOV 20% $20,000

One year later, it becomes:

Asset Current amount Current allocation
VTI $105,000 84%
SGOV $20,000 16%

If your rule is to rebalance only when the allocation drifts by more than 5%, then 84/16 may not need action yet.

If it becomes:

  • 90% VTI
  • 10% SGOV

then you can consider putting new money into SGOV, or selling some VTI for SGOV inside a retirement account.

Example 3: 70% VTI + 20% VXUS + 10% SGOV

This portfolio has three parts:

  • U.S. stocks.
  • International stocks.
  • Short-term cash / short bonds.

The target is:

Asset Target allocation Role
VTI 70% Core U.S. stock exposure
VXUS 20% International diversification
SGOV 10% Short bonds and cash management

If U.S. stocks surge over the next few years, it may become:

  • VTI: 80%
  • VXUS: 13%
  • SGOV: 7%

At that point, the portfolio is already clearly tilted toward U.S. stocks.

Possible rebalancing methods are:

  1. Put future new money into VXUS and SGOV first.
  2. If it’s in an IRA / 401(k), you can directly rebalance back to the target allocation.
  3. If it’s in a taxable account, try to avoid selling a large appreciated VTI position unless the drift is too severe.

Example 4: 80% VTI + 20% QQQ

This is not a stock + bond portfolio, but rather a style tilt within an all-stock portfolio.

VTI is the total U.S. market, while QQQ tilts toward growth stocks.

If QQQ rises a lot, the portfolio may become:

  • 70% VTI
  • 30% QQQ

At that point, the issue is not that the stock allocation is higher, but that exposure to growth and tech stocks has increased.If you originally only wanted QQQ to make up 20% of your portfolio, then you should consider rebalancing it back to that target.

The most common problem with this kind of portfolio is:

The more it goes up, the harder it is to sell; the more it goes down, the harder it is to buy.

That’s why it’s so important to write down your rules in advance.

Example 5: Target Date Fund

If you buy a Target Date Fund, such as a 2055 Target Date Fund, it does two things on its own:

  • It rebalances internally.
  • As the target year gets closer, it gradually lowers the stock allocation.

This type of fund is a good fit for people who want convenience.

The drawbacks are:

  • You have less control over the exact asset allocation.
  • Different fund companies have different glide paths.
  • If you also have a lot of investments in other accounts, you may still need to look at your overall asset allocation as a whole.

If all of your retirement assets are in one low-cost Target Date Fund, rebalancing becomes much simpler.

Tax and practical considerations for rebalancing

Prioritize adjusting in tax-advantaged accounts

If you have all of the following at the same time:

  • 401(k)
  • IRA / Roth IRA
  • HSA
  • Taxable Brokerage

I recommend rebalancing in the first three account types first.

The reason is simple:

  • Trades inside the account generally do not create capital gains tax in that year.
  • Adjustments are easier.
  • You do not have to worry about selling VTI or VOO and immediately reporting capital gains.

In Taxable Brokerage, it is best to avoid selling profitable positions as much as possible, especially VTI and VOO that have risen a lot over the long term.

Use new money and dividends to rebalance

For people who are still in the accumulation phase, new money is the best rebalancing tool.

For example:

  • If stocks have gone up too much, put new money into SGOV, BND, or international stocks.
  • If stocks have fallen too much, put new money into VTI, VOO, or VT.
  • If one account has too much cash, use future contributions to fill up the stock allocation.

The benefits of doing this are:

  • Fewer sales.
  • Fewer tax events.
  • Less psychological pressure.
  • Better suited for long-term execution.

Do not trade frequently just to rebalance

Rebalancing is not better just because it is more frequent. If you check your allocation every day and rebalance every week, it can easily turn into disguised trading.

For a typical household, you might consider:

  • Checking once a year.
  • Or checking once every six months.
  • Only making changes when the portfolio drifts more than 5% from target.

Fidelity’s rebalancing guidance also lists identifying the current asset allocation, comparing it with the target allocation, and deciding whether to adjust as the basic steps; it emphasizes that rebalancing helps restore diversification and redistribute risk and return potential across investments. I think what really matters for ordinary people is having a rule, not making the rule especially complicated.

Pay attention to Wash Sale and Tax-loss Harvesting

If you do Tax-loss Harvesting in Taxable, you also need to be careful not to trigger a wash sale.

For example, if you sell VTI at a loss and then immediately buy back the exact same or substantially identical asset, it may affect your ability to deduct the loss.

I will not go into too much detail here, but the main things to remember are:

  • Rebalancing and tax-loss harvesting can work together.
  • But do not make things overly complicated just to save on taxes.
  • If the amount is large, it is a good idea to ask a CPA or a professional tax advisor.

Do not look at each account separately; look at your overall assets

A lot of people make one mistake: they look at each account on its own.

For example:

  • 401(k): 100% stocks.
  • Roth IRA: 100% QQQ.
  • HSA: 100% VTI.
  • Taxable: 50% VTI + 50% SGOV.

Each account may look a bit messy on its own, but the overall mix may still be reasonable.

So a better approach is:

  • Look at asset allocation based on the household’s overall investment portfolio.

For example, if all of your and your spouse’s accounts combined look like this:

  • U.S. stocks: 70%
  • International stocks: 10%
  • Bonds / short-term bonds / cash: 20%

That is the ratio that truly affects risk.

Common questions

If stocks have gone up a lot, do I have to sell?

Not necessarily.

If the drift is not large, you can leave it alone. You can also use new money to buy the underweighted asset instead of selling stocks.

If the drift is large, for example your target is 80% stocks but it has become 95% stocks, then you need to seriously consider whether the risk is too high.

In a bear market, does rebalancing mean buying stocks?

It can.

If your target is 80% stocks and stocks fall to 65% after a bear market, rebalancing means buying stocks. That sounds very counterintuitive, but that is exactly the point of rebalancing discipline.

Of course, the premise is that your target allocation still fits you. If a bear market makes you realize you truly cannot تحمل 80% stocks, then that means your original risk setting was too aggressive.

Does rebalancing increase returns?

Not necessarily.

The main purpose of rebalancing is not to guarantee higher returns, but to control risk and maintain your target asset allocation.

In some market environments, rebalancing may help. In a long-term one-way rising market, the stock allocation that is not rebalanced may perform better. But that also means you are taking on more risk.

How often is it best to rebalance?

For most investors, once a year or once every six months is a reasonable choice.

You can also set a drift threshold, such as only rebalancing when the portfolio drifts more than 5% from target.

It is not recommended to trade frequently for very small drifts, especially in Taxable Brokerage.

Is SGOV cash or a bond?

SGOV is essentially an ultra-short-term U.S. Treasury ETF. In practice, it is closer to a cash management tool or a short-term bond tool than to a long-term bond fund.

It is suitable for parking short-term cash, money waiting to be invested, and low-risk allocations, but not as a replacement for long-term stock growth.

What if my 401(k) does not offer VTI or VOO?

A 401(k) usually does not let you buy ETFs freely; you can only choose from the plan menu.

You can look for similar substitutes:

  • S&P 500 Index Fund ≈ similar to VOO.
  • Total Market Index Fund ≈ similar to VTI.
  • International Index Fund ≈ similar to VXUS.
  • Bond Index Fund / Stable Value Fund ≈ the bond or low-risk portion.

Is rebalancing in Taxable complicated?

It is a bit more complicated than in retirement accounts.

That is because selling profitable assets may create capital gains tax. So in Taxable, it is better to use new money, dividends, and tax-loss harvesting to make adjustments and do fewer unnecessary sales.

Do I still need to rebalance a Target Date Fund myself?

If all of your retirement assets are in one Target Date Fund, the fund usually rebalances automatically on the inside.

But if you also have other accounts such as an IRA, HSA, or Taxable, it is still a good idea to look at the total allocation from a household perspective.

Summary

Rebalancing is a very important step in long-term investing.

It is not about predicting the market, and it is not about trading frequently. It is about making sure your portfolio does not drift away from your original plan.

Simply put:

  • If stocks have gone up a lot, risk may have increased.
  • If stocks have gone down a lot, the portfolio may have become too conservative.
  • Rebalancing brings the portfolio back to the target allocation.

For a typical household, I think the most practical rules are:

  1. First decide on your target allocation, such as 80% stocks and 20% short-term bonds.
  2. Check once a year or once every six months.
  3. Consider adjusting only when the drift is around 5% or more.
  4. Use new money, dividends, and payroll contributions to rebalance first.
  5. Prioritize adjustments in 401(k), IRA, and HSA accounts.
  6. In Taxable Brokerage, avoid frequent sales and pay attention to capital gains tax.

If you use a Target Date Fund or a Robo-advisor, rebalancing may already be done automatically. If you buy VTI, VOO, VT, QQQ, or SGOV on your own, it is best to set a simple rule for yourself.

Financial freedom does not come from just buying the right ETF; it comes from following a system over the long term:

  • Know how much money you need.
  • Choose the right accounts.
  • Buy low-cost index funds.
  • Maintain a reasonable asset allocation.
  • Rebalance regularly.
  • Stick with it for the long run.

We cannot control market ups and downs, but we can control portfolio risk and execution discipline.

That is the meaning of rebalancing.

The Path to Financial Freedom

Main guide

Tools and Practical Walkthroughs

If you're interested, you can also join our U.S. personal finance and insurance discussion group (if the QR code is no longer working, you can add our WeChat assistant: uscards101, and we’ll help get you into the group)