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Portfolio rebalancing

So, what is it exactly?

Portfolio rebalancing is moving your money between investments so you can maintain the perfect balance to help you achieve your financial goals.

Every investor is different. Some are young, and some are old; some want to use their money for retirement, and some want to have it at hand to buy a house; some people have a high tolerance for risk, while still other people’s idea of a thrill is watching compound interest accumulate in a savings account. When investors set up their investment strategy, they take variables like these into account and then decide where to put their money. That’s called asset allocation. But the thing about asset allocation is that it requires maintenance. You have to tinker with how much money is where. That’s called portfolio rebalancing.

Portfolio rebalancing is something that should happen throughout your investment life. Some rebalancing is to make sure you maintain the allocation you initially set up. And some portfolio rebalancing happens because your goals will change over time—you’ll want to get more conservative with your money as you get closer to retirement, for instance. As your asset allocation changes, you’ll need to do portfolio rebalancing.

What are the pros?

One of the biggest pros to portfolio rebalancing is that it keeps risk under control, and sometimes just maintaining a level of risk takes some action. Consider our friend Average Joe Investor. Mr. AJ Investor decides he wants 35% of his money invested in non-Canadian stocks and 40% of his money in ultra-conservative Canadian bonds. (What can we say? AJ is risk-averse.) One year later, because of changes in the value of his assets, half of his money is outside of Canada and only 30% is held in bonds. In order to maintain the level of risk he feels is right for him, he’s going to have to do some portfolio rebalancing by selling some foreign stocks and reallocating the money to bonds.

Portfolio rebalancing also takes some of the emotion out of investing. When a portfolio rises, it’s hard to sell (AJ might not have wanted to sell his high-flying foreign stocks, even though he should!), and when a portfolio falls, it’s equally hard to buy. By “forcing” investors to sell and buy at a predetermined time, portfolio rebalancing is as close to emotionless investing as you can get.

Is there anything to be careful about?

Portfolio rebalancing is not without its faults. First off, for investors who hate math, calculating percentages and then adjusting balances to reflect those percentages won’t be a lot of fun. If this is you, you may want to hire someone to help or invest with a firm that automatically rebalances your portfolio for you.

For people with small portfolios, the cost of selling and buying stocks and bonds every year can become proportionally expensive. And if the degree to which you currently vary from your allocation target is small (say, 39% in stocks rather than 40%), portfolio rebalancing might not be worth the trouble and cost.