Portfolio Rebalancing Explained: How and Why to Rebalance Your Investments

When you set up a long-term investment portfolio, you usually choose a target asset allocation — a mix of different asset classes that reflects your goals, your time horizon and how much short-term volatility you are prepared to live with. A common starting point for a long-term investor in their working years might be 60 per cent global equities and 40 per cent bonds, but the right mix is personal.

The challenge is that markets do not stand still. If equities rise 15 per cent in a year and bonds fall 5 per cent, a 60/40 portfolio could end the year closer to 67/33. That might sound like a good problem to have, but the portfolio has now become more concentrated in equities — and therefore more exposed to a future stock market fall — than the investor originally intended.

Rebalancing simply means selling some of what has grown and using the proceeds to buy more of what has fallen, bringing the mix back to its target. It is a deliberately mechanical, unemotional process, and that is part of the point.

Our article on Asset Allocation Explained covers how target asset allocations are typically set and structured.

There are two widely used approaches, often combined.

Many investors use a hybrid: they review the portfolio once a year, but only actually trade if drift has exceeded a threshold. Research suggests that rebalancing more often than this — monthly or quarterly — usually adds cost without improving long-term outcomes.

A common misconception is that rebalancing is mainly about boosting returns. Over long periods, the evidence is mixed: in strongly rising equity markets, a portfolio that is never rebalanced can outperform one that is, simply because it ends up with more equities. The primary purpose of rebalancing is risk control. It keeps the portfolio close to the level of risk you originally chose, rather than letting it drift into something more aggressive than you are comfortable with.

It also imposes a quiet discipline. By selling what has done well and topping up what has lagged, rebalancing nudges you towards the "buy low, sell high" principle that emotion often pushes investors away from.

Our article on Investment Risk Explained covers how risk relates to potential returns and why matching risk to your personal circumstances matters.

How you rebalance matters as much as whether you do it. Inside a stocks and shares ISA or a pension, you can normally sell and buy investments freely without triggering Capital Gains Tax or Income Tax on the switch. This makes them an efficient place to rebalance.

In a general investment account, things are more complex. Selling investments at a gain can use up the Capital Gains Tax annual exempt amount, which is £3,000 for the 2026/27 tax year. Gains above that level are taxed at 18 per cent for basic-rate taxpayers and 24 per cent for higher and additional-rate taxpayers (these rates apply to gains on investments such as shares and funds). Dividend income outside an ISA or pension uses up the £500 dividend allowance for 2026/27, with rates from April 2026 of 10.75 per cent for basic-rate taxpayers, 35.75 per cent for higher-rate taxpayers and 39.35 per cent for additional-rate taxpayers.

There are also transaction costs to think about — platform fees, fund dealing charges and any bid-offer spreads on funds. Frequent rebalancing in a general account can therefore quietly erode returns, so it usually makes sense to be more measured than you might be inside a tax wrapper.

If you are still adding money each month to your ISA or pension, you can often rebalance "naturally" by directing new contributions into the parts of your portfolio that are below their target weights, rather than by selling anything. Over time, this can keep the portfolio close to its targets without triggering any trades at all.

This is a particularly attractive approach for investors with smaller portfolios or those who actively dislike making sell decisions. For larger portfolios, where contributions are small relative to overall value, occasional rebalancing trades are usually still needed.

Our article on Long-Term Investing Explained covers how time horizon and regular investing interact over longer periods.

Rebalancing is a deceptively simple idea, but the right asset allocation in the first place is a much bigger question. So is how to coordinate rebalancing across multiple accounts — ISAs, pensions, general accounts — in a tax-efficient way. In some situations, particularly for investors with more complex circumstances or larger portfolios, working with a regulated financial adviser may be appropriate.