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NEW YORK (CNN/Money) - When I rebalance my mutual fund portfolio, should I just be trying to maintain the proper balance between stock funds and bond funds overall? Or should I also be rebalancing to maintain the balance between different types of stock and bond funds-say, large-cap funds vs. small-cap in stocks and long-term vs. intermediate-term in bonds?

-- Nancy, Milwaukee, Wisconsin

Rebalancing is one of those things that financial advisers and personal finance journalists like me tell people all the time that they ought to do.

Alas, I'm not sure that advice really gets through. So before I get to the specifics of how you ought to pull off this rebalancing act, let me make a brief case for rebalancing in the hopes that more investors will begin using this important tool for managing investment risk.

Let's assume that after putting some serious thought into your investing strategy -- which perhaps involved a trip to our Asset Allocator tool -- you decide that 60 percent stocks and 40 percent bonds is the right portfolio mix for you based on how long you intend to invest and your stomach for fluctuations in the value of your portfolio. And let's further assume that you own stock and bond funds that automatically reinvest all your dividends, interest and capital gains into new fund shares.

Now, if every year your stock holdings earned the exact same return as your bond holdings, your 60/40 mix would never change. For example, if you started out the year with $100,000, $60,000 of which was in stocks and $40,000 in bonds, and stocks and bonds each earned an 8 percent return over the next 12 months, you would end the year with $108,000, $64,800 of which would be in stocks and $43,200 in bonds. The proportions in your portfolio would be the same.

In the real world, of course, it's rare that the return for stocks and bonds is the same in a given year. And rarer still that the returns would be the same over a period of years.

So let's say that over five years, your initial $60,000 stock investment grew by 8 percent per year, while your $40,000 bond investment grew by 5 percent. At the end of 10 years, your stock holdings would be worth just under $130,000, while your bond holdings would total just over $65,000 for a total portfolio worth roughly $195,000.

But the difference between your $195,000 portfolio and your original $100,000 portfolio is more than $95,000. Your $195,000 portfolio is considerably more volatile.

The reason is that stocks now represent two-thirds of the portfolio's value vs. half originally, while bonds represent just one-third vs. half 10 years ago. So whether you realize it or not, you would be taking on a lot more risk or, to put it another way, your portfolio's value would jump around a lot more than when you created it 10 years ago.

All of which means that if you want to maintain the same balance between risk and reward in your portfolio, you've got to periodically rebalance your portfolio to bring it back to its original proportions.

If you don't, you've essentially changed your original investing strategy to a more aggressive one if stocks have become a larger portion of your holdings, or to a more conservative one if bonds have outperformed stocks and thus become a larger share of your portfolio.

People can and do disagree about how often you should do this rebalancing -- some say monthly, others quarterly, others annually, and still others suggest rebalancing whenever your holdings stray significantly from your original mix (whenever, say, your stock or bond mix varies by more than five percentage points from its starting point).

As a practical matter, I think annual rebalancing is just fine. Otherwise, it may become too burdensome, not to mention that more frequent rebalancing can drive up costs.

So, back to your question: how finely do you have to rebalance the various parts of your portfolio?

The most important part of rebalancing is to maintain your overall mix of stocks vs. bonds. That ratio is what's largely going to determine how your portfolio performs. So if you do nothing else, at least make sure that you rebalance every year to get back to your original overall stocks-bonds mix.

But if you truly want to maintain a consistent investing strategy, then you also ought to look beyond just stocks and bonds overall when you rebalance.

So, for example, if you started out with 85 percent of your stock holdings in large-cap stock funds and 15 percent in small-caps, then each year you should get back to that 85 to 15 mix. The same goes for international holdings, growth and value and even different types of bond investments. Ideally, you want to bring each part of the portfolio back to its original proportions.

Generally, you should do this by selling off parts of your portfolio that have outperformed and plowing the proceeds into the parts of the portfolio that have lagged. Besides restoring the right balance to your holdings, this move also has the effect of taking some of your money out of asset classes whose prices may be getting gaseous and into ones that may be, if not outright bargains, perhaps good buys. In effect, you'll be selling high and buying low.

Now, I don't think you have to be a fanatic about this. For example, if international shares are normally 15 percent of your holdings, but a run in foreign stocks has pushed them to 17 percent of your portfolio, I'd probably forego trimming my international holdings (especially if I were holding those shares in a taxable account where sales might trigger taxes).

Or, if I were investing new money, I might buy more foreign securities until I got that part of my portfolio back to where it should be. But rebalancing doesn't have to be a high-precision exercise. Staying within a few percentage points of your portfolio's proportions is good enough.

One final note: if you buy into the idea of rebalancing but just aren't interested in doing the work, you might consider buying a lifecycle or target date fund.

In these funds, the manager does the work for you, rebalancing the portfolio's proportions automatically. What's more, these funds go another step. Over time, they gradually shift the mix away from stocks toward bonds, thus creating a more conservative portfolio as you approach retirement.

Granted, you give up some control if you go this route. But it's certainly a better solution than not rebalancing at all.

Walter Updegrave is a senior editor at MONEY Magazine and is the author of "We're Not in Kansas Anymore: Strategies for Retiring Rich in a Totally Changed World."