Rebalancing with monthly contributions (no selling needed)
Rebalance your portfolio by directing new money to underweight asset classes. Formula, a 60/40 example, and when contributions alone are not enough.
You can usually rebalance without selling anything. Direct each new contribution to the asset class furthest below its target, and the portfolio drifts back toward your plan on its own. This avoids transaction costs and, in taxable accounts, avoids realizing capital gains.
Below is the formula, a worked example with real numbers, and the situations where contributions alone are not enough. Educational only, not individualized advice.
Why contribution-based rebalancing works
Traditional rebalancing sells winners and buys losers. In a taxable account, selling winners can trigger capital gains tax, and every trade can cost spread or commission. Contribution-based rebalancing avoids both by using fresh cash as the rebalancing tool.
The trade-off is speed. If drift is large and contributions are small, it can take many months to correct. For most people investing every month for decades, that is an acceptable price.
The formula
For each class, compute what it should be worth after the contribution, then subtract what it is worth now. Any positive gap needs money. Classes with negative gaps get nothing this month.
If the total of positive gaps is larger than your contribution, split the contribution in proportion to the gaps. If the contribution is larger, fill every gap and distribute the remainder using your target percentages.
Gap = (Portfolio + Contribution) × Target % − Current value Share of contribution = Class gap ÷ Sum of positive gaps × Contribution
Example: a 60/40 portfolio
A portfolio of $80,000 has a 60/40 target between stocks and bonds. After a strong stock market it holds $52,000 in stocks (65%) and $28,000 in bonds (35%). You contribute $2,000.
The new total is $82,000. Targets are $49,200 for stocks and $32,800 for bonds. Stocks are $2,800 over and bonds are $4,800 under. The entire $2,000 goes to bonds, bringing the mix to about 63.4% stocks and 36.6% bonds.
Assuming no market movement, bonds reach 40% after about $6,700 of contributions, or roughly three to four months at $2,000 per month.
- Month 0: 65% stocks, 35% bonds
- Month 1: about 63.4% stocks, 36.6% bonds
- About month 4: close to the 60/40 target
When contributions are not enough
Contribution-only rebalancing struggles when a class is far off target or your contribution is tiny relative to the portfolio. A common guideline is to consider selling if any class drifts more than 5 percentage points from target, but weigh taxes first.
In tax-advantaged accounts, selling has no tax cost, so rebalance there first. In taxable accounts, prefer new money, then consider selling lots with the smallest gains or realized losses.
- Check allocation across all accounts once a quarter.
- Compute gaps using the formula after adding the next contribution.
- Send money to the largest gaps first.
- If a class is more than 5 points off after several months, rebalance inside an IRA or 401(k).
Keep learning
Rebalance with every contribution
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