A well-crafted investment strategy is the foundation of any comprehensive financial plan. At its most fundamental level, that strategy requires determining the appropriate allocation between stocks and bonds; a balance that is never one-size-fits-all. Your individual circumstances, long-term objectives, and risk tolerance each play a defining role in establishing the right mix for your portfolio. But arriving at a target allocation is only the starting point of your investing experience.  

The more difficult challenge is knowing when to rebalance back to that target once markets have moved your portfolio off course. This question becomes particularly important during periods of heightened volatility. Should you rebalance on an annual basis? Quarterly? Monthly? How far should you allow your portfolio to drift from its targets before intervention becomes necessary? 

The stock market is unpredictable, which means there's no perfect formula for knowing exactly when to rebalance your portfolio. That said, there are practical steps you can take to keep your allocation on track without overcomplicating the process. In practice, every financial advisor approaches rebalancing a little differently, relying on their own set of guidelines to decide when the time is right to act. 

Develop your investment strategy

Building toward your financial goals starts with having a clear investment strategy. That means deciding what types of investments you'll hold and how much of your portfolio you'll put into each one. This can be as broad as splitting your money between stocks and bonds, or more detailed such as breaking things down by sector, such as large U.S. stocks, small U.S. stocks, international stocks, and real estate.  

You can go even further by specifying individual securities like stocks, mutual funds, or ETFs. Once your target allocation is set and your money is invested, the values of those investments will naturally rise and fall over time, causing your actual allocation to drift away from your target. This is completely normal. 

One of the biggest challenges individual investors face is keeping emotions out of their decisions. When a portfolio starts drifting from its targets, that movement tends to trigger an emotional response, and the same performance can be interpreted in completely opposite ways.  

A drop in value might prompt one investor to sell while convincing another investor it's the perfect buying opportunity. A sharp increase in price might have one person rushing to lock in gains while another sees it as a signal to add more. These reactions are entirely human and understandable. After all, market swings directly affect your personal wealth, but allowing those emotions to drive your rebalancing decisions is a recipe for poor outcomes. 

How can you eliminate the effect of emotions on your portfolio management technique? Determine a plan, set parameters ahead of time, and stick to it. Developing an objective guideline for managing your portfolio in both favorable and unfavorable market conditions can deter you from making panicked decisions that may harm the performance of your portfolio and may result in trading fees and taxes. Consulting with a qualified financial planner will help you eliminate your personal and emotional biases from your investment portfolio when the stock market starts to get volatile. 

Why should you rebalance?

In a well-diversified portfolio, different investments will naturally outperform or underperform one another at any given time. Over time, this uneven performance causes your overall allocation to drift away from the target mix you originally set; the mix designed to best reflect your financial needs. When that happens, it's important to take steps to rebalance allocation back in line. Without action, your portfolio can end up either more aggressive or more conservative than needed to reach your goals. 

Rebalancing keeps your allocation on track so your portfolio continues to perform the way you originally intended. It also presents a natural opportunity to harvest gains from investments that have done well and redirect those funds into sectors that have lagged, effectively buying more shares at relatively lower prices. 

One important caveat: this approach is best suited for portfolios built around mutual funds. While past performance is never a guarantee of future results, the overall stock market has historically grown over the long term. This is largely due to the market's built-in diversification across thousands of companies, with new ones constantly emerging and others fading out.  

When a particular sector or asset class goes through a rough patch and becomes underweighted in your portfolio, it can make sense to shift funds from your overweight positions into that declining area, as performance tends to revert toward its historical average over time. 

We cannot, in the same manner, say that individual companies have always increased in value over time – they can collapse, and plenty have. In this instance, you could be putting more money into a sinking ship. Owning highly concentrated positions in individual stocks is very risky because of single-stock risk. This can be mitigated by using funds that own hundreds or thousands of different stocks. 

It is also important to ensure you aren't rebalancing too quickly or too frequently. This is where your rebalancing plan and parameters come into play.  

How often should you rebalance?

Finding the right rebalancing cadence is one of the more practical challenges individual investors face. Rebalance too often and you'll accumulate unnecessary trading fees; costs that add up quickly each time you buy or sell a security. Rebalance too infrequently and your portfolio can drift far enough from its target that your risk level creeps well beyond your comfort zone.  

The appropriate frequency also isn't the same for everyone. Investors trading derivatives or holding short positions need to monitor their portfolios far more actively than someone taking a straightforward buy-and-hold approach with diversified mutual funds. For the average investor, daily rebalancing is far too frequent, but relying on an annual review alone may leave your portfolio exposed for too long. 

For investors who aren't financial professionals, a quarterly portfolio review is a reasonable place to start. Checking in once every three months strikes a practical balance for two key reasons. First, reviewing more frequently exposes you to short-term market noise that can trigger unnecessary rebalancing. Acting on short-term volatility is essentially a form of market timing, and market timing is a notoriously difficult game to win. To do it successfully, you need to get it right twice: selling at or near the peak and buying back in at or near the bottom. Since no one can predict with absolute certainty which direction the market will move, this approach carries significant risks. Reviewing less frequently allows the market to work through its short-term fluctuations on its own and reduce unnecessary transaction fees.  

At what point do you rebalance your portfolio?

You've built your investment strategy, established your target allocation, and put your money to work. Three months have passed and it's time for your first portfolio review. Some investments have grown, others have lagged, and your allocation has shifted. The question now is: how do you know when it's actually time to rebalance? 

We have talked about investments drifting "too far" from their target allocation, but what does this really mean in practice? Once again, there is no sole perfect answer, and each investor has their own preferences depending on their portfolio holdings. When determining when to rebalance, we are looking at the current value of the specified fund in comparison to what it should be based on your initial portfolio allocation mix. 

The same logic that pertains to how often you review your portfolio, applies equally to how often you rebalance it. Take a straightforward example: your target allocation is 80% stocks and 20% bonds. If market movement pushes your stock allocation to 81%, rebalancing back to 80% makes little practical sense. But if that figure climbs to 90%, it's probably time to act. Rebalancing too often leads to unnecessary trading costs and prevents the market from working through its natural short-term volatility.  

Going too long without rebalancing, on the other hand, allows your portfolio to stray so far from its target that it no longer serves the goals it was built around. The sweet spot lies in identifying a drift threshold that keeps your allocation reasonably on track without overreacting to every market fluctuation. 

At Milestone, one approach we use is setting relative variance parameters on the different funds we use. This is where you set upper and lower thresholds, allowing the asset class to fluctuate between these two values, but rebalance if it strays outside of the targets. Take a 20% relative variance rule as an example: an investor holding 20% in an S&P 500 index fund and 10% in a Russell 2000 index fund would rebalance the S&P 500 position when it falls below 16% or rises above 24% of the total portfolio, and the Russell 2000 position when it drifts below 8% or above 12%. This objective framework removes emotional bias from the decision, which is especially valuable during volatile markets when the urge to overreact is strongest. Tax implications should also be considered when trading in a non-retirement account. 

Summary

While rebalancing is critical to keeping your financial plan on track, the wrong approach can quietly erode the progress you've worked hard to build. At Milestone, we believe that rebalancing is done best when reviewing the portfolio often but trading as infrequently as possible. 

Establishing a clear investment strategy and setting objective parameters for your portfolio reviews is one of the most effective ways to take emotion and personal biases out of the equation, particularly during periods of market volatility. Staying disciplined and sticking to your original plan is essential to keeping your financial goals within reach. Rebalancing is what keeps your portfolio aligned with your intended risk profile and working toward those goals over time. 

The value in working with a financial advisor is that they take these tasks (and many others) off your plate, so you don't have to think about them. Portfolio management in line with your risk tolerance and rebalancing can be challenging. If you would like help with your investment management, and your overall financial plan, please reach out to our team.