How To Rebalance Your Investment Portfolio

How to rebalance your investment portfolioRegardless of past or future performance...

There will be times when you need to rebalance your portfolio.

That means, putting it back to the asset allocation you intended.

But, what is an asset allocation anyway?

In layman’s terms, this is your strategy for balancing investment risk with potential reward so it aligns with your long term investing goals. (Not to be confused with asset “location” – where you can hold your assets – usually for certain tax advantages.)

First, let’s define these terms briefly.

More on asset allocation

When you hear the term asset allocation think of the three main asset classes most investors hold:

  1. stocks,
  2. bonds, and
  3. cash

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As investors we want to combine investments that belong to those asset classes intelligently to:

  • reduce investment risk (the potential to lose money), and
  • increase investment return (the potential to make money).

You can therefore allocate assets – spread them around – in various percentages to strike your desired balance.

There is no one-size-fits-all asset allocation formula for all investors.

It’s up to you to decide what is right for you.

What is rebalancing?

Simply put, rebalancing is the process of realigning the mix of your assets (stocks, bonds, cash) back to match your investing goals.

Think of it in terms of your car. You typically rebalance the tires every time you get new ones installed. That way you’re not driving down the road towards your destination in a risky way. Same goes for your money.

Related: How To Make Your New Car Last Forever

Rebalancing can occur in a number of ways. I’ll highlight two main ones I’ve used:

  • buy more assets – without selling other assets – to get more of what you want.
  • sell existing assets – and use those proceeds – to get more of what you want.

The term "rebalancing" may imply you need an equal distribution of assets. (For example: 33% stocks, 33% bonds and 33% cash.) But, you know from our asset allocation definition above that’s NOT true at all.

Why? Because the mix of your assets is up to you.

Why rebalance?

Three things come to mind for me:

1. Get your portfolio back to your desired mix

You rebalance because stocks and bonds and cash all behave differently when it comes to their long-term performance over time, as they relate to market conditions and inflation-fighting power.

2. Align your changing financial needs

You rebalance because your needs change over time.

You will age. Your investing goals may change. You have different priorities when it comes to your money and what you need it for, including when you will spend it.

Rebalancing is a way to adjust your risk and reward. It gives you a much better chance of meeting your financial needs.

3. Increase your returns

You rebalance because studies show it can increase your returns without taking on more risk.

You can buy more of what you need, to get your balance back in check, at a low price. You can ride returns as stocks or bonds increase in value over time.

How do I rebalance my portfolio?

Over the years I’ve considered and experimented with the following:

1. Rebalance by time

This is easy. Pick one month a year – I used January for many years. Then, use that time to buy or sell assets to rebalance the portfolio every year without fail.

2. Rebalance by targets

This one is a bit trickier and can be more frequent. You choose to buy or sell assets based on small (or modest) gains or losses in your portfolio – say swings of +/- 5% or 10% or more. I’ve never really been a fan of this method because you have to monitor your portfolio more. It could also entice you to trade more than you should.

3. Rebalance by adding more cash and investing at certain times

The indexing guru’s from Vanguard call this their “time-and-threshold” strategy. You can read more details about their approach and excellent rebalancing practices here.

What do I do today?

I use approach #3 above each year with some nuances.

TFSA

Every year we strive to max our Tax Free Savings Account (TFSA) contributions. Those accounts hold Canadian dividend paying stocks. Each year, we purchase stocks that we believe are:

  • reasonably priced, and
  • aligned to the sector breakdown of the TSX Composite Index.

For example, take the iShares ETF XIC product. A popular product with many index investors. The TSX Index (and XIC) has a breakdown of roughly:

  • 35% financials (think banks and life insurance companies),
  • 20% energy (think Enbridge, Suncor, Canadian Natural Resources and more),
  • 12% materials (think mostly mining companies), and
  • a lesser amount of industrials, telecommunications companies and Real Estate Investment Trusts (REITs).

So, every January after TFSA contributions are made, I look to Canadian dividend paying stalwarts in these sectors to buy and hold going-forward.

RRSP

When it comes to other accounts, it’s a different story. I actually don’t worry about rebalancing assets in our RRSPs (Registered Retirement Savings Plans) very much.

For two main reasons:

  1. those accounts have more indexed products in them – mostly U.S. and international equities;
  2. I also don’t hold any bonds in those accounts. (I tell you the reason right here.)

That means I have little rebalancing work to do inside our RRSPs. There are no bonds to buy or sell, just equities to buy after enough cash builds, usually 3-5 times per year.

The only thing I really monitor is the balance between the Canadian content of our portfolio versus the U.S. and international content held. For that, I’m aiming at 50/50.

Related: Are Robo Advisors Right For Your Retirement Savings?

How to rebalance your portfolio?

I don’t think there is a perfect rebalancing recipe for you, but I do think rebalancing is an important activity.

Here are 5 points to consider:

  1. Rebalancing is admittedly more challenging with individual stocks than with a single fund for each asset class. Based on the design of our portfolio, I need to consider imbalances between my individual holdings more than an index investor.
  2. Be mindful of the number of transactions you make to rebalance your portfolio. More purchases mean more commissions. High fees are bad when it comes to investing. Fees are lost money forever.
  3. Although I love reinvesting dividends, consider stopping DRIPs so the cash portion of your accounts can build up over time. Then, use that cash to rebalance your portfolio with new purchases.
  4. When possible, try and rebalance your portfolio through buying more assets instead of selling first and then buying more. I believe the longer all money is invested and working for you, the better. You also have one less transaction fee to worry about.
  5. Time-based rebalancing helps avoid investor panic. Investor behaviour is a key ingredient to financial wealth – something I continue to work on myself. Although big market corrections can be a great time to rebalance your portfolio, your emotions might get in the way of good decision-making.

Some final thoughts

Last year was a great year for equities… but the strong performance of the stock markets is never guaranteed.

Fortunately, we can control some of that risk by setting an appropriate asset allocation and then following a sound rebalancing strategy to keep things in check.

Disclosure: Some links in this article may be affiliate links. We're letting you know because it's the right thing to do. Here’s a more detailed disclosure on how HTS makes money.

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Comments

Angelo
Angelo 's picture

Thanks, this is probably the most demanding exercise of a self-managed portfolio. Is there some app, tool, calculator or excel sheet template available to help folks rebalance?

April 11, 2017 @ 11:51 am
My Own Advisor's picture

Hi Angelo,

You're right, it can be demanding for DIY investors. I know, I am one :) I believe this is part of the value robo-advisors can provide along with asset allocation in the first place.

I recall MoneySense used to have one?
http://www.moneysense.ca/invest/portfolio-rebalancing-tool/

I think Kerry Taylor did some basic ones as well?
http://www.squawkfox.com/rebalance-portfolio/

I've developed my own spreadsheet. I should share that at some point! On my "Helpful Sites" page I have some tools and calculators for DIY investors.

Thanks for reading Angelo and being a fan of How To Save Money and this article.

Cheers,
Mark

April 11, 2017 @ 5:53 pm
Brian
Brian's picture

I've also developed my own spreadsheet for rebalancing across multiple accounts. I've created a public version with some test data – please feel free to give it a try.

You can find instructions by hovering over the column headings. I'd love to hear your feedback on how you think it can be improved.

NOTE: This is a PUBLIC document, so please don't put your real data in it!

https://goo.gl/gvI2VD

April 13, 2017 @ 8:24 am
reda taleb
reda taleb's picture

Hi Stephen, do you have a guide or a list that you recommend we should invest in the US or TSE markets ?

April 11, 2017 @ 1:24 pm
Marpy
Marpy's picture

Hi Stephan - Another excellent article on your part. I really like the 5 points in the end. I have been managing my own money for the past 40 years and your points make a lot of sense. I have though never been very concerned about any balance in my portfolio though. My thinking was that quality and what I called no brainers were more important. for example I have had more than half of my portfolio in Canadian Bank shares till recently (paid a good dividend, safe and growing). When interest rates were very high (for those who are old enough to remember), I had 80% of my portfolio in Ontario and Canada stet up savings bonds. You were getting a very high return, a raise every year and with no risk. How could you beat that?? :-). Different things work for different people and sometimes simplicity works best. As for the Canadian banks - sold them all between December of last year and January of this year. Why?? - Well with GTA and Vancouver housing bubble and my view of the Canadian economy and Trumps effect, I came to the conclusion that it was time to sit on the sidelines. 2% i was able to get from Orange is better than losing, ;-) JMO

April 11, 2017 @ 6:48 pm
My Own Advisor's picture

Hey Marpy,

Thanks for the kind words and the comment. I'm not quite old enough to recall the high rates of the 80s (although I did like the music growing up!) but I recall it was very hard to beat those returns.

Those days of high returns on fixed income are long-gone and likely gone for the next 20-30 years - so most actuaries say.

It will be very interesting to see what happens with our so-called RE bubble in Canada. It hasn't popped yet! Will it eventually?

Happy saving and investing,
Mark

April 11, 2017 @ 9:09 pm
cannew
cannew's picture

Re-balancing is an area I tried during my early stages of investments. Was it helpful or successful? I was never sure and I always worried about selling and/or buying just to spread my money across the board or adding to my lowest holdings because I less invested in that stock or sector.

When I settled on the DG strategy, specifically The Connolly Report, Asset Allocation was no longer a consideration when investing new money or at yearend. Over time, I had a list of stocks I wanted to invest in, ignoring all others. When I had money to invest I looked no longer than to my list. For each I had a buy price (or range) and if it happen I bought more of my largest so be it. The stock would generate the income I set. Over time different stocks would be the low price, but there was no attempt to buy sectors just to re-balance.

Was it better than re-balanceing? Who knows. What I do know is that my income rose and I never regretted or worried about which sectors or how much I invested in each. My objective was income generation from a select group of stocks, not the entire market and for me it worked.

April 14, 2017 @ 11:59 am
My Own Advisor's picture

Based on your comments on my site (and emails) cannew, you've done very well with your approach.

Asset allocation for most investors is a consideration though, since I think many investors likely don't have the same stomach to ride out their portfolio in volatile or down markets. Your approach however to buy low is smart of course.

My objective is a dual one, focus on income generation from a diverse group of stocks and index invest everything else. I know your approach worked for you and my approach is working for me. In the end, the plan you can stick to, to meet your financial goals is the best plan. Thanks for reading.

Mark

April 16, 2017 @ 12:10 pm

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