If you think about your investments as a Formula 1 engine and money as the gasoline that fuels it, portfolio rebalancing is the regular tune-up and adjustments required to make sure the engine continues to run as efficiently as possible.
Whether you’re aware of it or not, when you started investing you performed something called “asset allocation” — you came up with a mix of equities depending on a number of factors, including when you’ll need to access your money, and your tolerance for risk. Your financial goals will determine your asset allocations.
A pretty common mix is stocks and bonds. Stocks offer more upside, as well as more risk than bonds. Inevitably, some of your investments will outperform others. And without portfolio rebalancing, a mix that began at 85% stocks and 15% bonds might, in a matter of a year or two, warp to an allocation that’s 95% stocks and 5% bonds, leaving you overexposed in stocks and underexposed in bonds.
Periodic portfolio rebalancing will take care of that problem, buying more of some holdings, selling off some others, until you’re ship shape again at the comfortable asset mix where you began your journey. The major advantage of regular portfolio rebalancing is that the process takes much of the emotion out of investing — buying and selling happens not in response to gut feelings or financial news, but in response to a simple, regular principal of the passage of time. Math whiz investors may choose to rebalance on their own at predetermined intervals. Others may choose a far less onerous way — the kind of automatic portfolio rebalancing that Wealthsimple and other firms offer to investors.