Like building a house, learning how to rebalance your portfolio begins with creating a sound foundation. First, define your financial goals, timeline, and risk tolerance. From this assessment, map out a mix of financial assets such as stock and bond ETFs with the help of a financial advisor or robo-advisor or on your own.

You’ll typically own a greater percentage of stock assets when you're younger, while more conservative investors will lean towards a larger allotment of cash and bond investments. We’ve compiled the basics every investor should know and have structured this guide for rebalancing your portfolio so that it should answer the most critical questions. 

How to Rebalance Your Portfolio 

The goal in rebalancing your portfolio is not perfection, since as soon as your investments return to their predetermined percentages, prices will shift, causing the asset values to deviate. Rebalance your portfolio at least annually and consider these factors:

• How much has my portfolio deviated from my original asset allocation?
• Am I still comfortable with my current asset allocation, or has my situation shifted suggesting that I amend the asset mix?
• Have my goals or risk tolerance changed?

Ways to Rebalance Your Portfolio

There are several rebalancing strategies:

• Select a percent range for rebalancing, such as when each asset class deviates 5% from its asset weight. The window of drift tolerance can be as low as 1 or 2% or higher than 5%. It all depends on the tolerance of the investor and the time they're willing to dedicate to keeping the portfolio compliant to the set allocation.
• Set a time to rebalance. Once a year is sufficient, although some investors prefer to rebalance quarterly or twice per year. There’s no wrong or right strategy, although less frequent rebalancing will potentially lead to greater stock allocations and higher overall returns, along with greater volatility.
• Add new money to the underweighted asset class to return the portfolio to its original allocation.
• Use withdrawals to decrease the weight of the overweight asset. If stocks have increased 1%, and you are removing funds from the portfolio, sell a portion of the overweight stocks and withdraw the proceeds. 

Steps Needed to Rebalance Your Portfolio

First, track the asset allocation of your portfolio. You can maintain your records on a spreadsheet or use a free or paid investment monitor like Quicken or Mint. You're ready to proceed when your assets are listed and percent devoted to each asset class is recorded.

Step 1: Analyze 

Compare the current percent weights of each asset class with your predetermined asset allocation. Quicken or other tools can do this for you. Or use a spreadsheet to compare your current asset values with the desired percent.

Step 2: Compare

Notice the difference between your actual and preferred asset allocation. If your 80% stock, 20% bond portfolio has drifted to 85% stocks and 15% bonds, then it’s time to rebalance, either by adding new money or selling stocks and buying bonds. 

Step 3: Sell

To sell 5% of your stock assets, you’ll make a simple calculation. Assume your portfolio is worth $100,000 and your desired allocation is $80,000 in stock assets and $20,000 in bond assets. After the value drifts to $85,000 stocks and $15,000 bonds, you’ll sell $5,000 worth of stock investments.

Step 4: Buy

With the $5,000 proceeds from the stock sale, you’ll buy $5,000 of bonds. This will return your portfolio to its preferred 80% stock, 20% bond mix. 

Step 5: Add Funds

Let’s say that you want to add $10,000 to the portfolio. The value of your portfolio will be $110,000 with a desired asset mix of $88,000 in stock investments and $22,000 in bonds. (Multiply $110,000 by 80% for the stock allocation amount and multiply $110,000 by 20% to arrive at your dollar goal amount for the bond category).

Step 6: Invest the Cash

To rebalance a portfolio after adding additional cash, calculate the difference between the current value and the preferred value, for each asset class. Using our former example, we have $85,000 in stocks so we buy $3,000 of stocks, to reach the desired $88,000 stock allocation. Similarly, we buy $7,000 of the bond asset class to reach the desired $22,000 in bonds.

How to Use a Robo-Advisor to Rebalance Your Portfolio

A robo-advisor might be the best solution for those who prefer to outsource portfolio selection and rebalancing. Robo-advisors such as Wealthfront and Schwab Intelligent Portfolios are designed to offer investors access to well-diversified investment portfolios, rebalancing, and other features, such as tax loss harvesting, with low or no management fees. The most popular robo-advisors administer a quick survey to determine your investment goals, timeline, and risk. Ultimately, the survey results drive the investment portfolio. After investing, the top robo-advisors will rebalance your holdings on an as-needed basis, to keep your portfolio in line with the initial survey parameters.

Pros and Cons of Portfolio Rebalancing

Investment management, which includes rebalancing, requires a commitment. You’ll need to analyze your investments, to make certain they still meet your objectives. Periodically you’ll review the asset allocation you’ve selected and decide whether you’re comfortable with the ups and downs of the financial markets. You might choose to increase the stock allocation if you’re comfortable with greater risk, or increase the cash and bond portion if you’re nearing retirement or uncomfortable with occasional double-digit declines in your investment values.

Additional Tips to Rebalance Your Portfolio 

Rebalancing is one component of the investment selection and management package. Here are additional tips to aid in successful rebalancing:

• Avoid checking your investment values too frequently (daily or weekly). This can lead to a sense that you need to act, which typically leads to overtrading and inferior investment returns. 
• Create a personal investment policy statement, which includes your investment mix, asset allocation, and rebalancing parameters. Stick to your predetermined plan.
• In taxable accounts, look to minimize taxes. This involves selling losing positions to offset capital gains, or tax loss harvesting. 
• Maintain a long-term focus. It’s easy to get distracted by frequent movements in your investments, but acting on those changes can short circuit your long-term goals.

Remember that investing is a way to turn today's earnings into future financial security. Investing and rebalancing are designed to increase your returns over the long term, such as five or more years. For shorter-term goals, consider a certificate of deposit or high-yield money market account. 

The Bottom Line

Rebalancing will keep your preferred asset allocation in check and help to smooth out the volatility of your portfolio. When stock prices soar, rebalancing will force you to take some profits. When prices are lower, and an asset class declines in value, you’ll buy at lower levels. Ultimately, the best way to rebalance is the strategy that works for you. Less frequent rebalancing saves you time and might allow your winning assets to grow for a bit longer.