Your investment portfolio might look exactly the way you left it. But under the surface, its risk level may have quietly shifted. If stocks have rallied over the past year while bonds stayed flat, your once-balanced mix could now be tilted heavily toward equities — exposing you to more volatility than you originally planned for.
That shift is called drift, and the fix is called rebalancing. In this article, you'll learn what portfolio rebalancing is, why allocations drift over time, the benefits and trade-offs to consider, and how to approach rebalancing in a way that suits your goals — especially within Canadian registered accounts.
What is portfolio rebalancing?
Portfolio rebalancing is the process of realigning the weightings of the assets in your portfolio back to your original target allocation. Your target allocation is the mix of asset classes — such as stocks, bonds, and cash — that reflects your risk tolerance, time horizon, and financial goals.
Here's a simple example. Suppose you start the year with a 60/40 portfolio: 60% in equities and 40% in bonds. Over 12 months, equities return 20% while bonds return 2%. Without touching anything, your portfolio has drifted to roughly 68% equities and 32% bonds. That's a meaningfully different risk profile from where you started.
Rebalancing means selling some of the equities that have grown beyond their target weight and buying more bonds (or other underweight assets) to bring the mix back to 60/40 — or whatever allocation you've chosen.
Why portfolio allocations drift
Drift happens because different asset classes grow at different rates. In any given period, some investments outperform others. The winners naturally take up a larger share of your portfolio, while underperformers shrink in proportion.
This isn't a flaw in your strategy — it's just math. But the practical effect is that your risk exposure changes silently over time. In most cases, drift pushes your portfolio toward more risk, because equities tend to outpace bonds and cash over the long term. A portfolio that started at a moderate risk level can gradually become aggressive without you making a single trade.
The shift can also go the other way. During a stock market downturn, your equity allocation may drop well below your target, leaving you more conservatively positioned than you intended.
Benefits of rebalancing
It keeps risk aligned with your comfort level
The primary benefit of rebalancing is that it keeps your portfolio's risk profile consistent with your tolerance and time horizon. If you chose a 60/40 allocation because you wanted moderate growth with some downside protection, letting it drift to 75/25 defeats that purpose. Rebalancing brings you back to the risk level you consciously chose.
It enforces a buy-low, sell-high discipline
Rebalancing inherently involves trimming assets that have grown (selling relatively high) and adding to assets that have lagged (buying relatively low). This runs counter to the emotional impulse many investors feel to chase winners and abandon losers. By following a systematic process, you remove some of the behavioural bias from the equation.
It can smooth returns over time
Research suggests that rebalanced portfolios tend to experience lower volatility compared to portfolios left to drift. This doesn't necessarily mean higher total returns in every period — in a sustained bull market, a drifted portfolio heavy on equities may outperform a rebalanced one. But smoother returns can make it easier to stay invested through turbulent markets, which matters for long-term outcomes.
It creates a natural checkpoint
The act of rebalancing gives you a reason to review your portfolio and reassess whether your goals, risk tolerance, or life circumstances have changed. It's a built-in moment to ask: does this allocation still make sense for me?
Drawbacks and costs to consider
Transaction costs
Every time you buy or sell, there may be trading fees involved, though many platforms now offer commission-free trading on certain products. For portfolios with small balances, even modest fees can add up if you rebalance frequently.
Tax consequences in non-registered accounts
In Canada, selling investments in a non-registered (taxable) account can trigger capital gains. If you sell an asset that has appreciated, you'll owe tax on 50% of the gain at your marginal tax rate. This is one of the most important factors to weigh — particularly for larger portfolios held outside registered accounts.
It can cap upside in a bull market
When you sell outperforming assets to rebalance, you're intentionally reducing your exposure to whatever has been doing well. If that asset class continues to rise, your rebalanced portfolio will underperform one that let the winners run. This is the trade-off for maintaining your target risk level.
Over-rebalancing can erode returns
Rebalancing too often — say, after every small market move — generates unnecessary transaction costs and potential tax events without meaningfully improving your risk management. The goal is to correct meaningful drift, not to chase perfection.
Rebalancing methods
There are several common approaches to rebalancing, each with its own rhythm:
Calendar-based rebalancing: you review and adjust your portfolio on a set schedule — quarterly, semi-annually, or annually. It's simple and predictable, though it may not respond quickly to sharp market moves.
Threshold or tolerance-band rebalancing: you set a tolerance range around each asset class — for example, plus or minus 5 percentage points — and only rebalance when an allocation drifts outside that band. This approach is more responsive to market conditions and tends to result in fewer unnecessary trades.
Cash-flow rebalancing: instead of selling overweight assets, you direct new contributions (or reinvested dividends) toward underweight asset classes. This method avoids triggering taxable events entirely, making it especially appealing in non-registered accounts. The trade-off is that it works more gradually and may not fully correct large drifts.
Many investors use a combination of these methods — for instance, checking allocations annually but also acting if a 5% drift threshold is crossed.
Canadian considerations for rebalancing
If you hold investments in multiple account types, the order in which you rebalance matters for tax efficiency.
Start with registered accounts
Rebalancing inside a Tax-Free Savings Account (TFSA) or Registered Retirement Savings Plan (RRSP) has no tax consequences. Gains and losses inside these accounts don't trigger capital gains tax, so you can buy and sell freely to restore your target allocation. For that reason, it generally makes sense to do the bulk of your rebalancing within registered accounts first.
Use contributions to rebalance non-registered accounts
In taxable accounts, selling winners triggers capital gains. Where possible, use new contributions, dividend payments, or interest income to purchase underweight asset classes rather than selling overweight ones. This "cash-flow rebalancing" approach lets you move toward your target allocation without creating a tax bill.
Think about asset location
Asset location — which investments you hold in which accounts — can also affect your rebalancing strategy. For instance, holding fixed-income investments in your RRSP (where interest income isn't taxed annually) and equities in your TFSA (where capital gains are never taxed) can improve tax efficiency overall. When you rebalance, being mindful of asset location helps you avoid unnecessary tax friction.
Automated options exist
Some investment platforms and products handle rebalancing automatically. Robo-advisors typically monitor your allocation and rebalance as needed, often using cash-flow methods to minimize tax impact. Asset-allocation exchange-traded funds (ETFs) maintain a fixed mix of stocks and bonds within a single fund, rebalancing internally. These can be practical options if you prefer a hands-off approach.
How often to rebalance
There's no single correct frequency, but two common guidelines can serve as a starting point:
Once a year: an annual review is often enough for most long-term investors. It limits transaction costs and tax events while still catching meaningful drift.
When any asset class drifts 5 percentage points or more from its target: this threshold-based trigger ensures you act when drift is significant, regardless of the calendar.
The key caution is to avoid overdoing it. Rebalancing after every small market fluctuation adds cost and complexity without a proportional benefit. Markets move daily — your allocation strategy doesn't need to.
