Rebalance your investments

EPISODE SUMMARY

Over time your investment portfolio will move along with the market.  Stocks and bonds will move at different speeds and sometimes in different directions.  These investments in your portfolio won’t stay in the perfect split that you want.  To keep your risk profile in check and take advantage of lower prices in other assets, rebalancing is your friend!

✅ DOWNLOAD FREE RETIREMENT READINESS CHECKLIST


TOPICS IN THIS EPISODE

1. What is target asset allocation
2. What might lead you to need to rebalance 
3. Methods to rebalance 
4. Rebalance frequency 

OTHER EPISODES

20. Understanding Investment Risk 

21. Stocks, Bonds, or Cash? How do you Decide?

37. Dips, Corrections and Crashes


If you enjoy listening to the podcast, please leave a 5 star review on Apple Podcasts

--
Why bother filing your taxes?

XEQT vs VEQT. Which ETF is better?

Connect With Evan

Transcript

Hello and welcome back to the Canadian Money Roadmap Podcast. I'm your host, Evan Neufeld. Today is the last episode in my summer series focused on short topics on how to invest smarter and reduce your taxes.

Thanks again to all of you who have joined me over the summer here for these episodes. It was a bit of an experiment to see what it would be like doing episodes weekly, but I think I will be heading back to the bi-weekly format again come fall. But this will be the last episode in this summer series and I'm taking a break to do a little bit of camping next week. So this last episode is about the topic of rebalancing your investment accounts.

The idea of rebalancing comes from the fact or the understanding that when you invest, there should be a target allocation that you might have between stocks and bonds, based on your risk preference, your financial situation, your goals, and your timeline. Let's just use for sake of example, your target allocation is about 50% stocks and 50% bonds.

Now what happens throughout the year, day to day, is that these investments will move at different speeds. So when the stock market is performing well, the value of the stock portion of your portfolio will increase much quicker than the bond portion. But when stocks are doing poor, the opposite might happen, your bond performance might increase at a rate much, much faster. So the problem there can be a situation where periods of time, it might not be days, it could be years where stocks drastically outperform bonds over a period of time. So when you had wanted a 50% split between stocks and bonds, well as stocks continue to do better and better and better versus bonds, you might end up with a 70/30 split. Then your entire account is no longer as risk averse as a 50/50 split might be. Okay. So it has gotten much more risky as your risky assets have increased in value. Right? So that's a double-edged sword. Yes, you want to make the money, but now you're exposed to much more risk than you were before. So say this situation happens where now you're in a 70/30 split and the stock market crashes.  Well, now your portfolio is exposed to much more volatility than you had originally intended. So what do you need to do to prevent that from happening? Rebalancing!

So rebalancing can come in the form of three different methods. The first one could be by a new contribution. So if you are still in the accumulation phase of planning for retirement, you could adjust where you're making your contributions to, or if you're doing a lump sum contribution, for example.  So say again, in my hypothetical here, you wanted a 50/50, but your stock portion of your portfolio has increased to the point where now it's a 70/30. If you wanted to rebalance, you could do that by adding new money to the bond portion, which then brings up its value and gets it closer to that original split that you wanted.

This would fall under the idea of buy low. So what is the one thing that everybody knows about investing, but no one actually does: buy low, sell high. Okay. Rebalancing is all about buy low, sell high. If you are in a position to be doing additional contributions, rebalancing by buying the fund or the asset class or whatever the case may be, that is currently down or not as high value as you'd like it to be, buying that one to rebalance things is a good strategy to use.  The other end of that coin or the other side of that coin is the sell high strategy. So when you have a case like that and you have your stock bond split is now up to a 70/30, well than you can sell about 20% of your stocks and buy 20% more bonds and then it gets back to that even split.  So that's taking some profits off the table. This is a really tough thing to want to do and it's not always a perfect strategy. So I like to recommend to people to let their winners run a little bit, instead of being firm with having a 50/50 split. Just see how things go and put a feel out in the market.

If things get really out of whack, like beyond 15% in either direction, that's when you might want to start looking at some opportunities to do a rebalance. But if it goes to a 51/49 split or something like that, don't worry about it yet. You want to make sure that the things that are working in the current market environment have enough time to make sense.

The last option you can do for rebalancing is pretty much only available if you're investing in mutual funds.  With mutual funds, you can actually switch numbers of units. You can switch dollar amounts and things like that from one fund to the other, but with stocks, bonds, and ETFs. They're treated much the same. So there's no such thing as a switch with those types of investments, you have to do a sell and then a subsequent buy, which is fine.

But if you're incurring transaction costs to do that, rebalancing start to get expensive and it's a little bit tougher to do with exact dollar amounts and things like that. You don't have to get too picky, but it's just worth saying that there is a difference between the two and that is a convenience factor that's built into mutual funds.

So I alluded to this a little bit before, but the idea of rebalancing based on rules is something that I would highly recommend as opposed to feelings. The more ways that you can get feelings and emotions out of your investing the better.

So a rule that you could do, I briefly mentioned that, but you could take a look at when your portfolio is out of your target allocation by X percent. You might feel good about 10%, you might feel good about15 or up to 25. I wouldn't do any more than that, but anything within that range might be an appropriate time to take a look at rebalancing.  But if it stays kind of within that range, you know, bonds are moving up one month and stocks are doing a little bit better, or it might be a rising tide lifts all boats type of market where things are kind of moving in relatively similar fashion, you might not have to do much rebalancing. Just to have a look at the target allocation versus what your upper end threshold might be, and you can determine what that would be. But anything between 10 to 25% I think would be appropriate. 

Now the second time instead of doing it, or the second opportunity to rebalance based on a rule would be time.  So I think instead of just looking every day to see what your allocations are and then panicking. Set an alarm for yourself or something in your calendar for maybe every quarter, twice a year, or even once a year and just see, okay, July 1st is my rebalance day. Have a look at your portfolio and see where things are at.  If things are within the range that you'd like, leave it alone. If they're out of whack, then you can do some switching around, so switches, a new contribution or a selling high, and then buying low.  But for the vast majority of you that were probably using same asset allocation or portfolio type of product, like a one-stop shop ETF or mutual fund or things like that, a lot of the rebalancing happens for you. So you don't have to worry necessarily about your allocations there. The total value of that fund will go up and it will go down over time, but the target allocation within it should remain about the same.  Most funds that I'm aware of would do this on a quarterly basis, some do it monthly. I have seen ones that do it daily, which is a little crazy, but these funds are really good to take the pressure of rebalancing off your plate and put it onto a computer or at least a team of professionals that can do it for you behind the scenes.

So that was the look at rebalancing your portfolio. Again, the reason that you want to do that is to make sure that your risk profile stays in line with where it should be based on your risk preference and your timeline and your goals and your financial situation. You can do that by adding new contributions, to things that are low.  You can make a redemption from things that are high, and if you use mutual funds, you can actually just do switches to switch back and forth between the funds that are out of whack.

Remembered to not do this on a daily basis, or whenever you feel like it. Set up some rules for yourself to make sure that you're taking the best advantage and taking emotions out of your rebalancing decisions as much as you possibly can. Thanks again for listening to this summer series and I will be back again in fall with some bi-weekly episodes for you.

Thanks for joining me today on the Canadian Money Roadmap podcast. If you enjoyed today's episode, I'd really appreciate if you left me a review on apple podcasts with your biggest takeaway. If you have questions or ideas for topics you'd like me to discuss on future episodes, please reach out via my contact info in the show notes.

This podcast is intended to be educational in nature, and you should always consult your financial, tax and legal advisors before making changes to your financial plan. Any rates of return discussed are historical or hypothetical and are to be used for educational purposes only. Evan Neufeld is a Qualified Associate Financial Planner and registered investment fund advisor. Mutual funds are provided through Sterling Mutuals Inc.