Rebalancing

Explanation

Suppose your target is 60% stocks and 40% bonds. After a strong year for stocks, you might be at 66/34, which is a riskier portfolio than you chose. Rebalancing sells some of what is overweight and buys what is underweight to get back to target.

Common approaches:

• Calendar: rebalance on a schedule, such as once a year.
• Threshold (bands): rebalance only when an asset drifts beyond a set band, such as 5 percentage points from target.
• Cash-flow rebalancing: direct new contributions to underweight assets, or take withdrawals from overweight ones. This often avoids selling altogether.

Rebalancing is mainly a risk control, not a guaranteed return booster. In some periods it adds a bit of return by systematically buying low and selling high; in strong trending markets it can lag letting winners run.

Taxes matter. Rebalancing inside IRAs and 401(k)s has no immediate tax cost. In a taxable account, selling winners can realize capital gains, so many people rebalance inside tax-advantaged accounts first, use new contributions or withdrawals, or harvest losses at the same time. Trading costs are minimal at most brokers today.

In scenarios, you can choose a rebalancing rule. The app applies it within each simulated year and, for taxable accounts, includes any gains it realizes in that year’s taxes.

Example

You start with $1,000,000 at 60/40: $600,000 in stocks, $400,000 in bonds. Stocks rise 30% and bonds are flat.

• Stocks: $600,000 × 1.30 = $780,000
• Bonds: $400,000
• Total: $1,180,000; stocks are now $780,000 ÷ $1,180,000 = 66.1%

To rebalance to 60/40:

• Target stocks: $1,180,000 × 0.60 = $708,000
• Target bonds: $1,180,000 × 0.40 = $472,000
• Sell $72,000 of stocks and buy $72,000 of bonds

If you were withdrawing $72,000 for spending that year, taking it all from stocks would rebalance you without any extra trades.