You set up your portfolio with 70% in stocks and 30% in bonds. After a strong year for equities, stocks have grown to 85% of your portfolio. You haven't changed anything — but your risk profile has shifted dramatically without you noticing. Rebalancing is how you fix this: periodically returning your portfolio to its target allocation.
Rebalancing forces you to sell what has gone up and buy what has gone down — which is, mechanically, buying low and selling high. It's not a market timing strategy; it's a risk management discipline. When equities have a great run, they become a larger share of your portfolio, increasing your exposure to a potential correction. Rebalancing trims that exposure back to where you deliberately want it.
Two common approaches: calendar rebalancing (annually, or once every 6 months, regardless of drift) or threshold rebalancing (only when any asset class drifts more than 5% from its target). Research suggests threshold rebalancing is slightly more efficient — it avoids unnecessary trading when drift is small but catches large drift before it becomes a problem.
Annual rebalancing inside an ISA is typically sufficient for most investors. The transaction costs and tax implications of rebalancing too frequently erode the benefit.
Outside an ISA, selling appreciated assets triggers capital gains tax. Smarter approaches: redirect new contributions to underweight assets (no selling needed), use dividends to rebalance (invest income into what's underweight), or rebalance inside an ISA/SIPP where gains aren't taxed. The bed-and-ISA strategy — selling holdings in a general investment account and repurchasing them inside an ISA — can rebalance while gradually moving assets into a tax shelter.
The psychological benefit: rebalancing gives you a structured reason to buy when assets are down — the exact opposite of the natural instinct to flee. Setting it up as a rule removes the emotional element: "I rebalance in January, full stop." That discipline is worth almost as much as the mechanics.
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