Research on professionally managed portfolios has long suggested that the mix of asset classes you hold explains much of how bumpy your investment journey feels – often more than which individual stocks or funds you pick. That mix is called asset allocation, and keeping it on track over time is called rebalancing.
Try it: use our free Portfolio Rebalancing Calculator to work out exactly what to buy or sell.
This guide covers what asset allocation means, the factors that shape it, and the most common ways investors rebalance.
What Is Asset Allocation?
Asset allocation is how you divide your investments among broad categories, such as:
- Stocks (equities) – higher long-term growth potential, higher volatility.
- Bonds (fixed income) – generally steadier, with income from interest.
- Cash and cash equivalents – highest stability and liquidity, lowest long-term growth.
- Other assets – such as real estate funds or commodities, which some investors add for diversification.
If you are new to the first two, start with our guide to stocks vs. bonds.
What Shapes Your Allocation?
1. Time horizon
Money you will need in the next year or two is usually kept in stable assets like cash, because there may not be time to recover from a market drop. Money you will not touch for 20 years can generally tolerate more volatility in exchange for higher expected growth.
2. Risk tolerance
Risk tolerance is both financial (can you afford a loss?) and emotional (can you watch your portfolio fall 30% without selling in a panic?). An allocation you abandon during a downturn can do more damage than a more conservative one you stick with.
3. Goals and needs
Someone building wealth for retirement decades away will likely have a different mix from someone saving for a house deposit in three years, or a retiree drawing income.
Example Allocations
These simplified examples show how allocations differ in character. They are illustrations, not recommendations:
| Style | Stocks | Bonds | Cash | General character |
|---|---|---|---|---|
| Conservative | 30% | 55% | 15% | Lower swings, lower growth potential |
| Balanced | 60% | 35% | 5% | Moderate swings and growth |
| Growth | 85% | 15% | 0% | Larger swings, higher growth potential |
Writing your chosen allocation down, along with the reasons behind it, is one of the key parts of a personal investment policy statement.
Why Portfolios Drift
Once you invest, your allocation does not stay fixed. Different assets grow at different speeds, so the mix gradually changes on its own. This is called portfolio drift.
Here is a simple example. Suppose you start with $100,000 in a 60/40 portfolio: $60,000 in stocks and $40,000 in bonds. Over a strong year, stocks rise 20% and bonds rise 2%:
| Start | After one year | New weight | |
|---|---|---|---|
| Stocks | $60,000 | $72,000 | about 64% |
| Bonds | $40,000 | $40,800 | about 36% |
| Total | $100,000 | $112,800 | 100% |
Your portfolio is now riskier than you planned. After several good years for stocks, a “60/40” investor could easily find they are holding 70% or more in stocks – just before a downturn.
What Is Rebalancing?
Rebalancing means bringing your portfolio back to its target allocation. In the example above, returning to 60/40 would mean holding about $67,680 in stocks and $45,120 in bonds – so you would move roughly $4,320 from stocks to bonds.
Rebalancing has a useful side effect: it forces a disciplined “sell what has risen, buy what has lagged” habit. Its main purpose, though, is risk control – keeping your portfolio aligned with the level of risk you chose on purpose.
Common Rebalancing Methods
1. Calendar rebalancing
You check and rebalance on a fixed schedule, such as once a year. It is simple and easy to remember. Many investors pick a meaningful date, such as their birthday or the start of the year.
2. Threshold (band) rebalancing
You rebalance only when an asset class drifts beyond a set range – for example, more than 5 percentage points from its target. A 60% stock target would trigger rebalancing below 55% or above 65%. This avoids unnecessary trades when markets are calm.
3. Rebalancing with new money
Instead of selling, you direct new contributions or dividends into whichever asset class is underweight. This can reduce trading costs and, in taxable accounts, may avoid realizing capital gains.
Practical Considerations
- Taxes: selling investments in a taxable account can trigger capital gains tax. Rebalancing inside tax-advantaged accounts, or with new money, may be more efficient. Tax rules differ by country, so check your local rules.
- Costs: trading fees and bid-ask spreads add up if you rebalance too often.
- Emotions: rebalancing often feels uncomfortable, because it means buying the asset that has recently done worse. A written plan makes it easier to follow.
- Simplicity: balanced and target-date funds rebalance automatically inside the fund, which some investors prefer.
Key Takeaways
- Asset allocation – your mix of stocks, bonds, and cash – is a central driver of your portfolio’s risk.
- Choose a mix based on your time horizon, risk tolerance, and goals, and write it down.
- Markets cause portfolios to drift; rebalancing brings them back to the risk level you chose.
- Calendar, threshold, and new-money rebalancing are all reasonable approaches – consistency matters more than precision.
Important Disclaimer
The information in this article is for general educational purposes only and does not constitute financial, investment, tax, or legal advice. All investing involves risk, including the possible loss of principal. Examples are simplified illustrations, not predictions. Consider consulting a qualified professional before making financial decisions. See our full Disclaimer.
