Rebalancing your portfolio

How have stocks and bonds done over the previous six months? If there are disparities in the relative performances of various types of your investments, it’s time to rebalance.

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If values begin to shift in your portfolio, you’ll need to re-balance.

Your asset allocation has a big impact on your returns. The more you invest in stocks, the higher your returns over the long run. Bonds and treasury bills yield far less than stocks. But in the short run, T-bills in particular can protect you from a stock market setback.

You should assess your circumstances in determining your asset allocation. Do you earn steady money or are you living from paycheque to paycheque? Do you own your house? What size is the mortgage if you have yet to finish paying it off? Do you face child-care or elder-care costs?

Do you plan on contributing to one or more RESPs (Registered Education Savings Plans) or TFSAs (Tax-Free Savings Accounts)? Do you have a workplace pension plan? If you do, is it a desirable defined benefit plan or a less desirable defined contribution plan? Is your employer likely to survive over the long run? Do you expect to receive a handsome inheritance? When? Do you have a disease such as muscular dystrophy? There are many elements to consider.

Correcting portfolio drift

Based on your unique circumstances, set a suitable asset allocation. But ‘portfolio drift’ can disrupt your asset allocation. So far in 2021, for instance, Canadian stocks as measured by the S&P/TSX Composite Index have jumped by 15.7 per cent. That’s on top of surging stock prices since April, 2020. So far in 2021, the Canadian Universe Bond Index is down by 3.75 per cent. Stocks now account for a larger weight in your portfolio and bonds for a lower weight.

Let’s say, for example, that you’re a very conservative investor and you want half of your money in stocks and half in bonds. If your returns were identical to those of the indices, stocks would now account for 54.6 per cent of your portfolio and bonds, 45.4 per cent. If you want to restore your 50-50 split, there are a couple ways of doing this.

If you’re building your portfolio, you should put new money into bonds. When a takeover of one of your companies occurs, you should reinvest the proceeds into bonds. The same is true if you sell some of your stocks. Such actions will gradually raise the percentage of your bonds until they again reach 50 per cent of your overall portfolio.

If you’re withdrawing from the market, sell stocks. Especially low-quality stocks that fail to pay dividends. When bonds mature, reinvest into new bonds.

One positive aspect about rebalancing is that it makes you act as a contrarian investor. You’ll take profits from investments that have gone up in relative value. You’ll buy assets that have fallen in relative value on the cheap. Rebalancing also reduces your trading costs: brokerage commissions, bid-ask spreads, margin money interest among others.

This is an edited version of an article that was originally published for subscribers in the July 9, 2021, issue of The Investment Reporter. You can profit from the award-winning advice subscribers receive regularly in The Investment Reporter.

The Investment Reporter, MPL Communications Inc.
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