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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 because investments grow at different rates. You have to tinker with how much money is where when the numbers change. 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 change over time—you’ll probably want to get more conservative with your money as you get closer to retirement, for instance.

What are the pros?

One of the biggest advantages to portfolio rebalancing is that it keeps risk under control—even maintaining a level of risk often takes some action. Consider our friend Average Joe Investor. Say Mr. AJ Investor decides he wants 35% of his money invested in foreign stocks and 40% of his money in ultraconservative American bonds. (What can we say? AJ is risk-averse.) But it’s possible that a year after he starts investing, because of changes in the value of his assets, half of his money is now outside of the U.S. 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 don’t particularly enjoy complicated 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.

Or just invest with Wealthsimple. We perform this task for you at no additional cost.

If you don’t invest with us, and your portfolio is small, the cost of selling and buying stocks and bonds every year can be proportionally very expensive. And if you’re not far off from your allocation target (say 39% of your money is in stocks, and your target is 40%), portfolio rebalancing might not be worth the trouble and cost.

Finally, of course, there is the issue of taxes. Just because you’re savvy enough to rebalance your portfolio doesn’t mean you get to skip out on taxes if you happen sell at a higher price than you bought and reap a profit. Which we certainly hope is the case.