How To Rebalance Your Portfolio To Minimize Risk

If you’ve ever opened your investment account and seen that your asset allocation differs from what you previously set, know this is normal. 

Over time, market movements naturally shift your asset mix, and the value of everything in your portfolio may change, drift, or take up a different percentage of your portfolio than intended. 

If you’re experiencing this, it’s time to rebalance your portfolio. By buying or selling, you’re essentially realigning the weightings of assets to return to your desired asset allocation and level of risk exposure. Preventing portfolios from becoming too heavily weighted in one asset class or sector reduces vulnerability during market volatility.

Key Takeaways

• Rebalancing maintains your desired risk level by preventing portfolio drift toward riskier or more conservative positions.
• Your risk tolerance should guide your rebalancing approach, and you should reassess it periodically.
• Effective rebalancing strategies include constant-mix approaches, portfolio insurance techniques, and tactical allocation methods.
• Your rebalancing frequency should align with your investment timeline.

Here’s what you need to know about rebalancing your portfolio to minimize risk and keep you on track.

Factors To Consider To Assess Your Risk Tolerance

Determining your risk tolerance is key to long-term investment success. According to Kayla Rae Fernandez, CFP, who develops highly specialized financial plans for individuals and families with California Financial Advisors, it should be something folks focus on and continue to evaluate throughout their lifetime of investing. 

When rebalancing to minimize risk, consider: your financial stability (stable income and a big emergency fund can support more risk), your goals or when you need the money (shorter timeframes require less risk), and your age (younger investors can typically take more risk because there’s more time to recover).

“Overestimating risk tolerance can lead to severe consequences, including missed profit-taking opportunities, or worse, panic-selling during downturns,” Fernandez said. “Investors who sell in a downturn not only lock in losses but also risk missing the swift rebounds that often follow market declines.” 

Another thing to consider is your personal experience in terms of investment knowledge and emotional and practical response to market fluctuations.

Note

Experienced investors with time may better understand market cycles and maintain discipline during downturns. In contrast, newer investors might benefit from more conservative allocations until they develop confidence in their investment approach.

Fernandez points out that difficult markets, especially extended bear markets, test people because it’s easy to overestimate risk-taking tolerance when the market is strong. “In practice, I have found that presenting potential losses in tangible terms helps clients internalize potential risks and evaluate their capacity to remain invested during periods of market stress,” she said. 

Strategies To Rebalance Your Portfolio

1. Constant Mix

The constant-mix approach maintains fixed percentage allocations to different asset classes. When market movements cause these percentages to drift, investors buy or sell assets to restore the target allocation.

2. Investing in Long-Term Assets (Buy and Hold) 

Think of buy-and-hold as a non-rebalancing strategy. The focus is on purchasing quality investments with long-term growth potential and holding them through market fluctuations indefinitely. This passive approach minimizes transaction costs and timing errors, so it’s an alternative to rebalancing.

3. Constant Proportion Portfolio Insurance

Constant proportion portfolio insurance (CPPI) adjusts the allocation between risky and safe assets based on a predetermined floor value. As the portfolio value increases above this floor, exposure to risky assets increases. As the value approaches the floor, the allocation shifts toward safer assets. 

4. Using Management Strategies 

Stop-loss orders, dollar-cost averaging, and hedging are complementary risk management techniques.

Stop-loss orders automatically sell securities when they fall to a specified price, limiting potential losses by removing emotion from selling decisions. However, temporary market disruptions can trigger them.

Meanwhile, dollar-cost averaging involves systematically investing fixed amounts at regular intervals regardless of market conditions. According to David Rae, California-based financial planner and president of DRM Wealth Management, this approach mitigates risk by reducing the impact of market volatility. 

“When prices are high, fewer shares are purchased, and when prices are low, more shares are acquired,” he said. “It may seem counterintuitive, but you will end up with more shares that aren’t as good at the time of purchase, which over time should help you earn more on your investments.” 

Dollar-cost averaging can help force you to see investments in your portfolio that have had the most significant increases in value, which may be leading them to an overhaul, Rae said. 

 For broader portfolio protection, hedging strategies involve offsetting positions through options contracts or inverse ETFs to protect against adverse price movements. 

Tip

Combining these strategies creates multiple layers of protection and can be particularly valuable during periods of market volatility when emotional decision-making often leads to subpar outcomes.

Fernandez noted, “An investor’s rebalancing strategy should remain relatively consistent over time.” Incorporating these risk management techniques can help maintain discipline regardless of market conditions. 

5. Recalibrating Your Portfolio

Recalibration is reassessing the asset weights and overall strategic allocation based on changing market conditions, personal circumstances, or the economic outlook. 

This more comprehensive approach ensures that the target allocation and the rebalancing thresholds remain appropriate as investment conditions evolve. 

“If nothing else has changed, you probably can let your financial plan run for a few years before making big changes,” Rae said. “If you have major life changes like a job change, marriage or divorce, additions to the family, or perhaps an inheritance, you should review and adjust your current financial plan.” 

What Kind of Investment Risks Are There?

Investment risks include: 

• Market risk (overall market movements)
• Interest rate risk (impact of changing rates on investments)
• Inflation risk (erosion of purchasing power)
• Credit risk (possibility of default)
• Liquidity risk (inability to sell quickly without significant loss)
• Concentration risk (overexposure to a single investment type or sector)

What Is the 5/25 Rule for Rebalancing?

This 5/25 rule suggests rebalancing when an asset class deviates 5 percentage points from its target allocation or 25% relative to its target.

What Is the Best Frequency for Rebalancing a Portfolio?

The optimal rebalancing frequency depends on transaction costs, tax implications, and market volatility. Common approaches include calendar-based rebalancing (quarterly, semi-annually, or annually) or threshold-based rebalancing (when allocations drift beyond predetermined percentages).

Should I Rebalance My Portfolio When the Market Is Down?

Rebalancing during market downturns can be psychologically challenging, but may present opportunities to purchase assets at lower valuations. Still, Fernandez noted, “rebalancing should be executed during periods of market strength to preserve long-term returns and prevent selling at inopportune times.” Ultimately, the decision should align with your long-term strategy rather than reacting to short-term volatility.

How To Rebalance a Portfolio for Retirement?

Retirement portfolio rebalancing typically involves gradually increasing allocation to income-generating and lower-volatility investments while maintaining some growth exposure to combat inflation. Critical considerations include required withdrawal rates, other income sources, and expected longevity. 

The Bottom Line

Effective portfolio rebalancing is essential for maintaining appropriate risk levels and achieving long-term financial goals. By systematically realigning investments to match your target allocation, you can enhance returns while managing volatility. The most successful rebalancing approaches align with your personal risk tolerance, financial situation, and investment timeline.