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By Ian Salisbury
January 14, 2016

The stock market tumbled again on Wednesday, entering correction territory (defined as a 10% drop from a previous high.) That means you’re likely to hear talk of investors “rebalancing” their portfolios.

As the market pushes stock prices around, the makeup of your portfolio changes. For instance, after a 10% market decline like the current one, a 60-40 stock-bond portfolio becomes a 58-42 portfolio, assuming bonds stay flat. That may seem relatively tame. But over time, such moves can throw your asset allocation seriously off-kilter. Rebalancing essentially means bringing your portfolio back to its intended composition, in the above scenario by selling bonds to buy more stocks.

Think you need to make a move? Here’s what you need to know.

Pick a target and stick to it

Investors tend to talk about rebalancing when the market hits milestones, such as a 5% or 10% move, or at a specific time of year, because rebalancing isn’t something to do on the spur of the moment. The idea is to pick a number that triggers you to act, and stick to your plan—in good times and bad. If you do decide to make your rebalancing trades based on a market milestone, pick a relatively large one, say a move of at least 5%. One recent Vanguard study found that waiting until your mix is 10 percentage points off target produces better long-term results than shifting more often, without adding much more volatility.

Read Next: U.S. Stocks Are at Their Lowest Since September

Consider all your accounts

While the concept of rebalancing is simple, in practice it can get quite complicated. The reason: trading in your brokerage account can have different tax consequences than trading in your 401(k). If you want to rebalance in the most efficient fashion you have to do some planning, thinking across your entire investment portfolio. Need to add bonds? It may make sense to do all the buying in a retirement account, since the income they throw off won’t be taxable there. Planning to shed winning stocks in your brokerage account? Try to sell some losers at the same time to offset the capital gains.

Don’t feel you have to rebalance at all

Many investors like rebalancing because it smooths the market’s ups and downs, making it easier for them to stick to their strategies. (The worst thing you can do is panic and sell out of the market during a bear market.) But some smart investors skip the step altogether. When legendary investor Jack Bogle ran the numbers on historical 25-year periods several years ago, he found rebalancing actually hurt returns in the long-run, albeit, only by a hair.

Advertiser Disclosure

The purpose of this disclosure is to explain how we make money without charging you for our content.

Our mission is to help people at any stage of life make smart financial decisions through research, reporting, reviews, recommendations, and tools.

Earning your trust is essential to our success, and we believe transparency is critical to creating that trust. To that end, you should know that many or all of the companies featured here are partners who advertise with us.

Our content is free because our partners pay us a referral fee if you click on links or call any of the phone numbers on our site. If you choose to interact with the content on our site, we will likely receive compensation. If you don't, we will not be compensated. Ultimately the choice is yours.

Opinions are our own and our editors and staff writers are instructed to maintain editorial integrity, but compensation along with in-depth research will determine where, how, and in what order they appear on the page.

To find out more about our editorial process and how we make money, click here.

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