Should I rebalance during market crashes?

Should You Rebalance💡 Definition:The process of realigning your investment portfolio back to your target asset allocation by buying and selling assets. During Market Crashes?

Red numbers everywhere. Your stomach drops as you watch your portfolio value shrink. The natural instinct is to either sell everything or freeze in panic. But what if the smartest move is something else entirely?

When markets are in a freefall, a disciplined strategy called rebalancing can be your best defense. The answer to whether you should rebalance during a crash is a firm yes—if you’ve done your homework first.

The Importance of Rebalancing

Think of rebalancing as a course correction💡 Definition:A market correction is a decline of 10% or more from a recent peak, signaling potential buying opportunities. for your investments. It’s the simple act of buying or selling assets to get your portfolio back to its original target mix.

Let’s say you started with a classic 60/40 split between stocks and bonds💡 Definition:A fixed-income investment where you loan money to a government or corporation in exchange for regular interest payments.. If stocks plummet 30%, your portfolio might suddenly look more like a 50/50 split. That’s a bigger shift in risk💡 Definition:Risk is the chance of losing money on an investment, which helps you assess potential returns. than you might think. Rebalancing nudges you back to your 60/40 plan, keeping you aligned with your long-term goals.

Why Rebalance During Crashes?

1. Risk Control💡 Definition:The process of identifying, assessing, and controlling threats to your financial security and goals.: Rebalancing forces you to follow the classic advice: "buy low, sell high." When stocks are down, they make up a smaller piece of your portfolio pie. To get back to your target, you sell some assets that have held their value (like bonds) and buy more stocks at a discount💡 Definition:A reduction in price from the original or list price, typically expressed as a percentage or dollar amount..

2. Avoiding Drift: Without a regular check-up, your portfolio can drift far from its intended path. Historical data shows a 60/40 portfolio can easily become an 80/20 portfolio over a long bull run. That's way more risk than you signed up for! Rebalancing keeps that drift in check.

3. Improving Returns: It might feel counterintuitive, but this discipline can pay💡 Definition:Income is the money you earn, essential for budgeting and financial planning. off. Studies from firms like Vanguard have shown that rebalanced portfolios often have better risk-adjusted returns over the long haul, partly because they lose less during major downturns.

Strategies for Effective Rebalancing

Pre-Crisis Planning

The best time to plan for a market storm is when the skies are clear. Don't wait for the panic to set in.

Create a simple rebalancing plan that states exactly when and how you’ll act. This document is your anchor, removing emotion from the decision-making process when things get chaotic. Need help defining your targets? Start with our asset allocation guide.

Rebalancing Approaches

• Calendar-Based Rebalancing: This is the "set it and forget it" method. You review and rebalance your portfolio on a fixed schedule, like every quarter or once a year. It’s simple and ensures you never forget.

• Threshold-Based Rebalancing: This approach is more reactive. You set a trigger, for example, if any asset class💡 Definition:A group of investments with similar behavior, risk, and regulatory profiles (e.g., stocks, bonds, cash). drifts more than 5% from its target. When it crosses that line, you rebalance. This can be more effective in volatile markets.

Consider Liquidity💡 Definition:How quickly an asset can be converted to cash without significant loss of value and Taxes

• Liquidity: Can you actually sell what you need to sell? Make sure you have enough cash or liquid assets💡 Definition:Assets that can be quickly converted to cash without losing value—like savings accounts, stocks, and money market funds. to make rebalancing moves without being forced to sell something at a terrible time.

• Taxes: Selling assets in a taxable brokerage account💡 Definition:A brokerage account lets you buy and sell investments, helping you grow wealth over time. can trigger capital gains💡 Definition:Profits realized from selling investments like stocks, bonds, or real estate for more than their cost basis. taxes. However, a market crash can also be an opportunity for tax-loss harvesting, which could help offset the taxes from your rebalancing gains.

Real-World Scenario

Let's make this real. Imagine your portfolio is worth $1 million, with a 60/40 stock💡 Definition:Stocks are shares in a company, offering potential growth and dividends to investors./bond allocation ($600k in stocks, $400k in bonds).

The stock market crashes, and your stocks lose 30% of their value. Your portfolio is now worth $820,000 ($420k in stocks, $400k in bonds). Your new allocation is roughly 51% stocks and 49% bonds—far from your target.

To rebalance, you would sell about $72,000 in bonds and use that cash to buy stocks at their new, lower prices. This brings you back to your 60/40 target, positioning you perfectly for the eventual recovery. A Morningstar analysis of similar scenarios confirms this strategy cushions the blow during a downturn.

Common Mistakes and Considerations

• Emotional Decisions: The hardest part is sticking to the plan when every instinct screams "sell!" Don't let fear drive your decisions. Trust💡 Definition:A trust is a legal arrangement that manages assets for beneficiaries, ensuring efficient wealth transfer and tax benefits. the strategy you made when you were calm and rational.

• Ignoring Liquidity: Don't get caught in a cash crunch. If you can't easily sell assets to buy others, your rebalancing plan won't work.

• Overlooking Taxes: Always be aware of the tax implications. A surprise tax bill can eat into your returns, so plan accordingly.

Bottom Line

Rebalancing during a market crash isn't just a good idea; it's a core discipline for serious investors. It keeps your risk level where you want it and systematically positions you to benefit from a recovery.

The whole game is won before the crash even happens. Create your rebalancing plan today, decide on your triggers, and commit to the process. When the market turns, you’ll be ready to act with confidence instead of fear.