The 5% rule: a simple threshold for rebalancing decisions
Most investors rebalance too often or not enough. Here's a simple rule that removes the guesswork.
The problem with calendar-based rebalancing
Many investors rebalance on a fixed schedule — quarterly or annually — regardless of what their portfolio actually looks like. The problem is that calendar-based rebalancing can trigger unnecessary trades when your allocation hasn't drifted meaningfully, and can leave you overexposed to risk when it has.
A threshold-based approach is more efficient: you only rebalance when a position has moved far enough from its target to actually warrant action.
What the 5% rule says
The 5% rule is simple: rebalance any position that has drifted more than 5 percentage points from its target weight. If your target for VTI is 40% and it's now at 46%, that's a 6-point drift — time to act. If it's at 43%, that's within the band — leave it alone.
This rule works because 5 percentage points represents a meaningful shift in your risk profile without being so sensitive that normal market volatility triggers constant trading. It's the sweet spot between too loose and too tight.
Applying it in practice
Set a drift alert for each of your holdings at ±5% from target. Check in when an alert fires. If contributions can close the gap, use those. If the drift is too large to fix through buying alone, consider a partial rebalancing sale.
For smaller positions — say, a 5% target weight — a ±5 point rule means you'd act anywhere between 0% and 10%. That's a doubling or complete disappearance of the position, which is too wide. For positions under 10% target weight, consider using a proportional rule: alert at ±50% of the target weight instead. So for a 5% target, alert at 2.5% or 7.5%.
Why it reduces trading costs and taxes
Threshold-based rebalancing trades less frequently than calendar rebalancing on average. Fewer trades means lower transaction costs and, in non-registered accounts, fewer taxable events. Over a 20-year investment horizon, the savings from reduced trading can compound meaningfully.
Setting it up
In Wealth Rebalancer, go to the Alerts page and set a drift threshold for each holding. The default suggestion is 5% — but you can customize it per position. When a holding crosses your threshold, you'll get notified and can decide whether to act via contribution or sale.