Direct answer: When a 60/40 portfolio drifts to 68/32, the first step is a threshold check: 8 percentage points exceeds the 5-point band, so rebalancing is warranted. The rebalancing trade is calculated as the difference between current and target dollar values for each asset class. For a $750,000 portfolio, that means selling $60,000 of equities and buying $60,000 of bonds. Where the trade happens matters as much as the trade itself: executing it inside a 401(k) costs no capital gains tax. Redirecting upcoming 401(k) contributions entirely to the bond fund avoids any sale at all and closes part of the gap tax-free.
Portfolio Rebalancing in Practice: Worked Example and Portfolio Context
How do you calculate how much to sell and buy in a rebalancing trade?
Investor profile: Alex, age 45, $750,000 combined portfolio (a $500,000 taxable brokerage account and a $250,000 401(k)), target allocation 60% global equity / 40% bonds. Annual review date: August 30.
After a 14-month equity bull market, the portfolio has drifted. Current values:
| Account | Equity Value | Bond Value | Total |
|---|---|---|---|
| Taxable brokerage | $360,000 | $140,000 | $500,000 |
| 401(k) | $150,000 | $100,000 | $250,000 |
| Total | $510,000 (68%) | $240,000 (32%) | $750,000 |
Threshold check: Equities are 68%, target is 60%: drift of 8 percentage points. This exceeds the 5-point tolerance band, so rebalancing is warranted.
Trade calculation: Target portfolio at 60/40 on $750,000:
- Target equities: $750,000 x 0.60 = $450,000
- Target bonds: $750,000 x 0.40 = $300,000
- Current equities: $510,000 (excess: $60,000)
- Current bonds: $240,000 (shortfall: $60,000)
The rebalancing trade is: sell $60,000 of equities, buy $60,000 of bonds. After the trade: equities $450,000 (60%), bonds $300,000 (40%).
How can you rebalance a 401(k) to avoid triggering capital gains taxes?
Before placing any taxable sale in the brokerage account, Alex should check whether the entire rebalancing trade can be executed tax-free in the 401(k).
Option 1: 401(k) internal trade. Alex's 401(k) holds $150,000 in equities and $100,000 in bonds. Within the 401(k), Alex can sell $60,000 of the equity index fund and buy $60,000 of the bond fund. This trade has no tax consequence: no capital gains are realized inside a 401(k). After the 401(k) trade:
- 401(k): $90,000 equities + $160,000 bonds = $250,000
- Taxable: $360,000 equities + $140,000 bonds = $500,000
- Total: $450,000 equities (60%) + $300,000 bonds (40%) = $750,000
Target reached. No taxable sale placed. The brokerage account is unchanged.
Option 2: Contribution redirection. If Alex contributes $2,000 per month to the 401(k) and the rebalancing gap is $60,000, Alex can redirect 100% of 401(k) contributions to the bond fund for the next several months. This closes approximately $24,000 of the gap over four months without any sale. The remaining gap can then be addressed via an internal 401(k) trade for the remaining $36,000 when the next annual review fires. This approach avoids even a 401(k) internal sale if patience allows a multi-month contribution approach.
When the 401(k) alone cannot close the gap
If the rebalancing gap exceeds the total assets in the 401(k), or if the 401(k) has already been fully rebalanced in prior periods, the investor may need to sell in the taxable account. In that case, selling equities with the lowest unrealized gain (or realizing a taxable loss in equities that have declined) is more tax-efficient than selling the most appreciated lots. Most major brokerage platforms allow investors to select which tax lots to sell. Choosing highest-cost lots first minimizes the taxable gain per dollar sold.
How often should you review your portfolio for rebalancing?
After completing the rebalancing review, the last step is scheduling the next one. For Alex's two-asset-class 60/40 portfolio with a 5-point threshold, an annual review is sufficient. The next review is set for August 30, 2027.
Annual review works because:
- A 5-point threshold rarely triggers in quiet markets; most annual reviews result in no trade.
- Annual reviews in August (or any month outside January) avoid the noise of tax-year-end trading and market seasonality that can distort the timing of rebalancing decisions.
- Setting a fixed recurring calendar event removes reliance on memory and motivation.
Investors who should consider more frequent (quarterly) review:
- Those within 5 to 7 years of retirement, where allocation drift has a larger impact on sequence-of-returns risk.
- Those with multi-asset portfolios including alternatives or small/mid-cap tilts, where individual asset class volatility is higher and 5-point threshold breaches happen more frequently.
- Those with only tax-advantaged accounts, where the cost of more frequent rebalancing is minimal.
The annual review calendar entry should include: current allocation vs. target, whether a threshold is breached, which accounts to rebalance in first, and any contributions to redirect before placing a sale. Documenting this at each review creates a record of decision-making that is valuable both for personal accountability and for understanding long-run rebalancing behavior.
Frequently Asked Questions
How do you calculate how much to sell and buy in a rebalancing trade?
Calculate the target dollar value for each asset class at the target weights (target weight x total portfolio value). Compare each asset class's current value to its target. The difference is the rebalancing trade. For a $750,000 portfolio targeting 60/40: target equities = $450,000, target bonds = $300,000. If current equities are $510,000 and bonds are $240,000, the rebalancing trade is sell $60,000 of equities and buy $60,000 of bonds. Executing this inside a 401(k) or IRA costs no capital gains tax.
How can you rebalance a 401(k) to avoid triggering capital gains taxes?
Rebalancing inside a 401(k) or IRA triggers no capital gains taxes because these accounts are tax-advantaged. An investor can sell overweight funds and buy underweight funds within the account without immediate tax consequence. Alternatively, redirecting future 401(k) contributions entirely to the underweight fund for several months closes part of the gap without any sale. This contribution-redirection approach is most effective when the gap is modest relative to annual contribution amounts. When the rebalancing gap exceeds what the tax-advantaged accounts can absorb, taxable account sales become necessary, and selecting highest-cost-basis lots first minimizes realized gains per dollar sold.
How often should you review your portfolio for rebalancing?
Annual review is sufficient for most investors using a two-asset-class portfolio (equities and bonds) with a 5-percentage-point tolerance band. The review should be on a fixed calendar date and documented so it occurs consistently. Quarterly reviews are appropriate for investors within 5 to 7 years of retirement (where drift affects sequence-of-returns risk), those with multi-asset portfolios where individual asset class volatility is high, or those with only tax-advantaged accounts where rebalancing costs are minimal. Consistency matters more than frequency: an annual review that actually happens every year produces better outcomes than a quarterly schedule that is skipped whenever markets are volatile.