• To properly balance a portfolio the first step is to understand your investing goals and appetite for risk.
  • When rebalancing, it's important to consider all your accounts and the tax implications.
  • You should monitor your portfolio for imbalance at least once per year.

As an investor, you set long-term goals that will guide key decisions including how much money you're willing to risk, the types of accounts you use, and when you'll retire.

While those long-term goals may not change, your portfolio certainly does over time. These changes are a result of natural movements in the stock market and the assets you've selected. If left unchecked, this could have a significant impact on your financial outlook. The key to reducing this risk is creating a balanced portfolio and reviewing it regularly to make sure it stays that way. 

What is a balanced investment strategy? 

With a balanced investment strategy, your objective is to create a portfolio that has the right mix of stocks and bonds to align with your investing goals and appetite for risk. This approach is intended to help reduce potential volatility during rough patches in the market. 

Balanced investing relies on the nature of how stocks and bonds typically behave over time. Stocks, while more volatile historically, outperform bonds gaining 7% to 10% on average annually. In the short term, however, stocks are more vulnerable to severe losses. Bonds are historically known to offer more stable returns with less volatility, but with the drawback of lower growth. 

A balanced investment strategy is a more holistic approach to investing when compared with other approaches including those focused on income, capital preservation, and growth. For example, an investor who follows an income investing strategy will likely focus primarily on blue chip dividend stocks and high-quality bonds. Their main goal is to buy assets that will produce a consistent income in retirement. Because of this, their mix of stocks and bonds may not adjust periodically based on age or risk.

A balanced approach aims for equilibrium between risk and reward, which means it could be more growth-focused for younger investors and more income-focused for those that are closer to retirement.  

How to build and maintain a balanced portfolio 

Building a balanced portfolio begins with understanding what your risk tolerance is and creating a target allocation that matches up. 

A risk tolerance questionnaire is a set of survey questions that help investors illustrate how they would react during certain market conditions. The questionnaire helps determine a target allocation of what a balanced portfolio should be based on the answers to each question.

When assessing if a portfolio is balanced, you compare it to the most recent risk tolerance questionnaire taken. Typically, you should complete a questionnaire at least once per year

"This is important because target asset allocations reflect the most appropriate exposure to equities, fixed income, and cash for the investor," says Sabina Smailhodzic Lewis, a CFP® professional and co-owner of Avant-Garde Wealth.

If you're a do-it-yourself investor you can use Vanguard's questionnaire here.  

A best practice is to have separate target allocations for each financial goal. Your retirement accounts may have a different allocation than the investments you may have set aside for a child through a custodial account or 529 plan. 

For example, your answers to the questionnaire might determine a target allocation of 60% stocks and 40% bonds, which has long been considered a good balance for moderate-risk investors. The answers provided for a young child, however, might indicate a more aggressive and riskier mix of 80% stocks and 20% bonds since they won't need the money for several years and can absorb the long-term ups and downs in the stock market. 

What is portfolio rebalancing?

Portfolio rebalancing is the process of adjusting your portfolio back to your intended target allocation. Even if you start by creating a balanced portfolio, your portfolio can become unbalanced due to changes in the market. 

This often happens because equities tend to earn higher returns than bonds, which means they represent a larger portion of the total value of your investments over time, according to Lewis. "The further an asset allocation drifts from the target asset allocation, the less appropriate the investor's portfolio becomes," she says.

Failing to rebalance your portfolio becomes increasingly perilous as you get closer to retirement. This is because your target allocation is largely influenced by the number of years you expect to continue working. Typically, you should become increasingly more conservative with your asset mix as you get older to avoid losing too much money if the stock market suddenly turns sharply lower soon before retirement.

How to rebalance your investment portfolio

With your target allocation in mind, to rebalance your portfolio first take a look at how your assets are currently allocated. Keep in mind that you should account for all of your investing accounts. This may include their 401(k) held at your employer (as well as accounts that may not have been rolled over) plus any other IRAs and brokerage accounts held with popular retail apps like Robinhood, M1 Finance, and others. 

In most cases, you should be able to find out what your current allocation is by logging in to your brokerage account. If your portfolio is scattered across different brokerages, consider using an app like Personal Capital to help aggregate and organize your accounts to get a full picture of your allocation. If you're savvy with Microsoft Excel you can also use it to monitor your allocation.  

For example, let's say you reviewed a portfolio that you hadn't revisited during a period when the stock market was rallying. You find that it's out of balance. The asset allocation is 90% stocks and 10% bonds, but your preferred mix for that account was 80% stocks and 20% bonds.

To rebalance your portfolio back to the target levels in this case you have two options. You could sell 10% of your stock holdings and invest the money in bonds. Alternatively, if you have the cash on hand you could add 10% to the bond portfolio without selling. The second option can become less practical depending on the size of the portfolio and how far out of balance it is.

When you should rebalance your portfolio

The most common rule of thumb is to rebalance your portfolio at least once per year with quarterly rebalancing being the maximum recommendation. But remember that rebalancing is more about how far the portfolio has drifted, if it has drifted at all.

"Five percent drift is a good default number in terms of when to rebalance," says Kevan Melchiorre, a CFP® professional and co-founder of Tenet Wealth Partners. "But this is more of a personal preference depending on your situation and risk tolerance.  As long as you are evaluating once a year and ensuring that your target asset allocation is still appropriate for your situation and goals, then that's most important."  

The bottom line

Like regular maintenance on a vehicle or home, rebalancing your investments should be a part of your regular financial tune-up routine.

Start by taking account of where you are as an investor with a risk tolerance questionnaire and compare those results against how your portfolio is currently allocated. From there adjust as needed to the target allocation and check back in on a regular schedule.

"Whenever you build a portfolio, you should be doing so with a purpose and your goals in mind," Melchiorre says. "If your portfolio sways too far from your targets, then that might mean too much risk."
Kevin L. Matthews II
Kevin L. Matthews II is a No. 1 bestselling author and former financial advisor. He has helped hundreds of individuals plan for their retirement in addition to managing more than $140 million in assets during his advisory career. In 2017, he was named one of the Top 100 Most Influential Financial Advisors by Investopedia. Kevin holds a bachelor's degree in Economics from Hampton University and a certificate in financial planning from Northwestern University. In 2020, he graduated from the University of Texas at Austin with a Master's in Technology Commercialization (MSTC).