Rebalancing: The Secret of Investment Success

Psst! Wanna hear a secret? Investment success doesn’t come from picking great stocks and mutual funds, nor does it come from knowing when to get in and out of the market or when a company is about to grab the brass ring or fall on its face.

Nope, investment success lies in the fairly simply process of deciding how to spread your investment eggs among various baskets (asset allocation or AA) and sticking to that decision until there is good reason to change (rebalancing).

Rob Carrick detailed some examples of AA for various ages in his post “Adapting to Risk with Age.”

Once you have decided how much you want to invest in the three main asset classes (cash, bonds and equities), the real trick to making asset allocation work is rebalancing. Wealth managers estimate that anywhere from 60 per cent to as much as 80 percent of a portfolio’s return comes from these two tasks.

Rebalancing involves looking at your portfolio from time to time and making sure it stays close to your original allocations. For example, say you have chosen this AA for your RRSP:

  • 10% Cash (such as a GIC)
  • 40% Bonds
  • 25% Canadian Equity
  • 25% U.S. Equity

Then, let’s say the market goes on a tear as it did in the beginning of 2011. As a result, in April your asset allocation might have looked like this:

  • 8% Cash
  • 32% Bonds
  • 30% Canadian Equity *
  • 30% U.S. Equity *

* The proportions of your cash and bond decreased because the equities increased.

The percentages show that your equity portion has jumped to 60 percent of your overall portfolio from 50 percent. Rebalancing is the process of bringing a portfolio back to its original asset allocation when the proportions get out of whack.

If you are contributing money regularly, you don’t need to sell anything; you simply need to divert new deposits to the fixed income part of your portfolio until the proportions return more or less to the original allocation. You can also use cash in the account from interest and dividend income.

Rebalancing means that you need to take a gander at your investment statement and read the section that lays out your asset allocation. If you can’t find it, contact your adviser or, if you are a DIYer with an account at a bank discount brokerage, call the helpline or go into your branch and talk to one of the licensed advisers.

Don’t get crazy and rebalance with every hiccup of the market. Research shows that micromanaging actually reduces a portfolio’s return and, in any event, you’ll waste money on unnecessary fees. Once or, at most, twice a year is usually sufficient over time.

Once you get the hang of rebalancing, you will have the foundation of a strong portfolio that is more resilient during turbulent times.

Next blog: Does rebalancing mean that buying and holding is wrong?

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3 Responses to Rebalancing: The Secret of Investment Success

  1. John Mooney says:

    IT is all very well to say rebalance, but in this enviorment with hardly any individual bonds available,
    it is hard to sell good dividend paying stock,to buy into bond funds funds with their high MER’S.after
    inflation;taxes and the MER you are in are in a negative position.This has worked well over the past
    25 or so years but maybe not the next 25, Let me give you an example,when i came to Canada 47 years ago, i was going to get a job with a pension and i did with a good pension.together with my rrsp i was laughing. but guess what with 25 years on the job the company pulled the plug on the pension ,and all my planning went out the window ,i was lucky or smart enough to continue with my RRSP and do my own investing through a self directed plan..

  2. I can certainly see your point. But the current low interest rate situation is but a slice of time, as was the ultra high rate environment in the 1980’s. The problem is that we have a terrible record of predicting what is going to happen on the financial markets and when. Don’t forget, that if you are still contributing to an RRSP then you don’t necessarily need to sell anything to rebalance. You can simply use new money and put it into the asset class which is lagging. Also you can use the cash from dividend payments to buy into the lagging asset class.
    Finally, don’t get obsessive about rebalancing. Only do it when the structure of your portfolio really gets out of whack. I recommend taking a look every 6 to 12 months or if there is a cataclysmic change in the market, a la 2008.

  3. Night Rider says:

    Your idea is well received. But it is not for everyone. For example, I worked all my life in several private companies. None of them had pension plans. I have no RRSP now. But with the lucrative earning I had, I invested in accounts outside of RRSP. As a retired person now, my income is mostly from investments in dividends, pref shares, DRIPs (30 years old) and some ETF’s. No bonds. With or without RRSP, at some point in time everyone have to pay tax.

    That said, when re-balancing – the ones that are cash cows have also increased in their share price. Fortunately, I do not have many duds in my portfolio. I will be reluctant to sell even some of it just to rebalance. My time horizon is such, growth is not in my radar. Income bearing instruments are my focus. Even during 2008, my drop in total portfolio was insignificant. Why rebalance? Why fix if it ain’t broke? Things are humming along fine. So you see – rebalancing is not for everyone.

    I do not read any analysts reco. They are 100% accurate after the fact. They explain why such ‘n such happened. But never BEFORE something happens or when warning bells are ringing. 2008/2009 is a fine example. No one warned about the imminent financial armageddon back in 2007. I did all this investments by myself with certain “intuition” – to choose companies by reading their annual reports and balance sheets. I trade with a discount broker. I do not know how but my formula is working.

    I learned over time that cluttering up one’s thoughts with an analyst’s opinion leads one to take the wrong path. After all, it is my opinion.