Why, when and how to rebalance your portfolio

Your investment portfolio needs a plan to help you reach your financial goals. Asset allocation is a relatively straightforward investment strategy that can help you to balance investing risks and rewards.

An asset allocation strategy establishes the relative proportions of equities, fixed income, and cash-based investments in your portfolio. Each of these asset categories has a different level of risk and different return potential. Your asset allocation mix is personal to you because it must be appropriate to your tolerance for risk, time horizon and objectives. You should aim for an asset allocation model calibrated to meet your goals, while exposing you to a level of risk you’re comfortable with.

How to determine your asset allocation mix
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Why you need to rebalance your portfolio

So, you’ve chosen an asset allocation model, and created an investment portfolio with an asset mix appropriate to your goals, risk tolerance and investing time horizon. That’s great!

But you’re not finished. With self-directed investing, you can’t just set it and forget it.

Over time, your allocation mix will change as markets shift. You’ll need to review and rebalance your portfolio periodically to ensure that it stays aligned to your investing goals, risk tolerance, and time horizon.

What is rebalancing?

Rebalancing means adjusting the securities in your portfolio so it matches your original asset allocation. So, it could mean selling some of your equities and using the proceeds to buy more fixed income investments (or vice versa) so that your portfolio gets back to the allocation that matches your risk tolerance.

Let’s assume you originally set your asset allocation at a 60/40 split of equities and fixed income. If the stock market has performed well over the years or you’ve continued to invest regularly in one asset class over the other, your original 60/40 allocation of equities and fixed income might shift closer to 70/30 or 80/20, and you will need to sell some equities to get back to where you want to be.

Unless you’re using a single asset allocation fund for your portfolio that automatically rebalances for you, this is likely something that you will have to do yourself. If you're not someone who wants to revisit your investments at least annually, you might prefer an automated investing approach that does your rebalancing for you. Qtrade Guided Portfolios is one such automated investing service, which builds you a professionally designed portfolio suited to your financial goals, risk tolerance and investment time horizon. The investment professionals that manage these portfolios also regularly rebalance the investments for you.

When you should rebalance your portfolio

There are no hard and fast rules about when or how often an investment portfolio should be rebalanced. It depends entirely on your asset allocation target mix and how your portfolio has been affected by market movements.

Investors tend to look more closely at their portfolio during down markets, but it’s a good idea to review your portfolio regularly regardless of market conditions. Your asset allocation can drift if certain assets have outperformed or underperformed. Portfolio rebalancing will help you to maintain your target asset allocation and reduce your exposure to risk outside of your comfort zone.

How to rebalance your portfolio

Let’s assume again that your asset allocation has a 60/40 split of equities and fixed income. If your stock holdings have performed well, your original 60/40 allocation of equities and fixed income may have shifted to an overweight position in equities. And if you received any quarterly dividend payments during the year, you may also have a cash position, possibly bringing your asset allocation to 70% equities, 25% fixed income and 5% cash.

To rebalance your portfolio to its original allocation, you’ll need to sell a portion of your equities and reinvest the proceeds, as well as your existing cash position, in fixed income. That will bring your asset mix back to its 60/40 split.

Other rebalancing considerations

As financial markets ebb and flow, different asset classes, sectors, and companies will outperform or underperform. This is why you must rebalance your portfolio periodically to keep it aligned with your target asset allocation mix.

However, even if you maintain your optimal asset mix between stocks, bonds and cash-based holdings, concentration risk within those allocations can arise. Let’s say you’ve enjoyed exceptional gains in a single stock or from stocks in a single sector, like technology. As the value of that holding or sector allocation increases, its weighting within your portfolio increases. Your portfolio may be exposed to concentration risk by being overweight in that area or stock. If the weighting of a specific sector or stock makes up a large part of your portfolio, it may be smart to lock in those gains and reduce your exposure to that sector so that your portfolio is more balanced. Alternatively, you may want to increase your exposure to other industries that may provide a benefit in new market environments.

Creating the right investment portfolio for you means building a portfolio that matches your personal risk tolerance and investing goals. In periods where market environments change and different stocks, industries and sectors go through periods of volatility, it’s natural for investors to start thinking more critically about the risks in their portfolio. While it’s often best to stay focused on your long-term goals, it never hurts to give your portfolio a little check-up once or twice a year to make sure you’re still on track.

How Qtrade can help

Qtrade Direct Investing’s Portfolio Score is a great way to give your investments a check-up, letting you evaluate the various risk exposures in your existing portfolio. This scoring tool lets you compare your portfolio’s performance against both domestic and global benchmarks. It also evaluates your individual securities (Canadian and U.S. stocks, exchange-traded funds and Canadian mutual funds).

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The information contained in this article was obtained from sources believed to be reliable; however, we cannot guarantee that it is accurate or complete. This material is for informational and educational purposes and it is not intended to provide specific advice including, without limitation, investment, financial, tax or similar matters.