How to build and rebalance an investment portfolio
A portfolio is the mix of asset classes you own: bonds, cash, domestic and international stocks, real estate. The target allocation, the percentage you want in each class, matters more for long-term results and risk than picking individual investments. Over time, the classes that rise the most take up more space than planned, and the portfolio drifts from its target. Rebalancing brings it back.
Two ways to rebalance
| Method | How it works | Pros and cons |
|---|---|---|
| Contribution only | New money goes to the classes below target | No sales and no taxable gains; may take a few months |
| Sell and buy | Sell what is above target and buy what is below | Back to target at once; may trigger taxes and fees |
Example
A $58,500 portfolio with a 35% target in short-term bonds actually has 51% there, while international stocks are at 3% against a 15% target. A $2,500 contribution goes mostly to the classes furthest below target, and the portfolio gets closer to plan without selling anything.
Why diversification reduces risk
Asset classes do not all rise and fall at the same time. When they have low correlation, a drop in one is partly offset by others, and the portfolio swings less than the average of its parts. That is why a mix of stocks and bonds can deliver a reasonable return with much less volatility than stocks alone.
How often to rebalance
- Check the portfolio once or twice a year, or whenever a class drifts more than about 5 points from target.
- Prefer rebalancing with new contributions and dividends; sell only when the drift is large.
- In tax-advantaged retirement accounts, rebalancing by selling usually has no tax cost.
- Change the target itself only when your goals, horizon or risk tolerance change, not because of recent market moves.