Rebalance portfolio as you invest and reinvest

You regularly receive cash as fixed-income investments mature, takeovers occur, and you earn interest, dividends and capital gains. Rebalance your portfolio as you do your ordinary investing.

Studies show that your strategic asset allocation (how you spread your money among different types of investments) greatly affects your returns. So it’s important to set long-term asset allocation targets to maximize your returns, given your circumstances. Generally, the more stocks you own, the more you earn. That’s because in the long run, stocks are much more lucrative than bonds or cash—even after terrible times for stocks, such as in the autumn of 2008 and early 2009.

Price changes, however, will move your portfolio away from your desired asset allocation. The solution to this problem is to rebalance your portfolio. That is, sell asset classes that are up in relative value and buy asset classes that have fallen in relative value. Besides eliminating portfolio drift, rebalancing can let you profit from contrarian investing.

Keep rebalancing as you buy and sell

The trouble is, rebalancing is costly. You pay brokerage fees for buying and selling. You usually pay the bid-ask spreads. And you also pay capital gains taxes instead of keeping unrealized capital gains working for you—except in tax-deferred accounts.

Given these costs, we advise you to tie your portfolio rebalancing to your regular investing program. The fact is, fixed-income investments mature and you earn interest and dividends. Some of your companies will face takeovers; you’ll have new money to invest and so on.

Let’s say that you’re still building your portfolio. Then you should reinvest cash you receive plus any new money you add in a way that you coincidentally rebalance your portfolio. While you’ll incur costs from doing so, these are costs that you would’ve faced anyway.

Retirees can rebalance as they withdraw

If you’re a retired investor, you may have no need for investment income—particularly if you’re lucky enough to belong to a generous defined benefits pension plan. You, too, can rebalance your portfolio as you reinvest the cash that your portfolio generates. Again, there are no added costs to such rebalancing.

Other retirees, by contrast, need to withdraw money from their portfolios. If this is your situation, then sell in a way that rebalances your portfolio.

For instance, if bonds beat stocks in 2016, you could lower your exposure to bonds by letting some mature. As you withdraw the money you need, you’ll move closer to your desired asset allocation. When you sell stocks, consider selling those in the sectors that have done best.

Consider alternative investments

Individual investors once had few asset classes (or types of investments) to choose from: There were common stocks, fixed-income investments such as bonds (including preferred shares) and cash such as Treasury bills or Canada Savings Bonds. You now have more asset classes to choose from.

You can, for instance, use REITs (or real estate investment trusts) to buy into office towers, apartments, hotels, commercial and industrial real estate. Keep in mind, too, that REITs avoid the higher income taxes that most income trusts have faced since the start of 2011. While residential real estate may soon weaken, real estate in general could rise if loose monetary and fiscal policies are too effective and eventually lead to runaway inflation.

As another example, you can buy into venture capital funds that invest in private companies and receive tax credits for doing so. When the stock market is receptive to IPOs (or Initial Public Offerings), well-managed venture capital funds can profit handsomely. But today’s volatile and nervous financial markets currently make venture capital funds less attractive.

You have even more options. As yet another example, you can buy mutual funds and ETFs (exchange-traded funds) with exposure to a variety of industries or countries.

One advantage of having so many asset classes to choose from is that it lets you diversify more widely. This can both improve your returns and reduce your risk at the same time.


The Investment Reporter, MPL Communications Inc.
133 Richmond St. W., Toronto, On, M5H 3M8, 1-800-804-8846

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