Adjusting portfolio allocations back to target weights by buying or selling assets.
Rebalancing is the process of adjusting your portfolio back to your target asset allocation. Over time, different investments perform differently, causing your allocation to drift. If you target 60% stocks/40% bonds and stocks rise significantly, you might end up at 70% stocks/30% bonds. Rebalancing involves selling some stocks and buying bonds to return to 60/40. Rebalancing has three benefits: it forces a "buy low, sell high" discipline (selling winners, buying underperformers), maintains your intended risk level, and locks in gains. Rebalancing can be done annually, quarterly, or when allocations drift beyond tolerance bands (e.g., ±5% from target). Rebalancing in tax-deferred accounts (401k, IRA) avoids tax consequences; taxable accounts require careful planning to minimize capital gains taxes.