Guest blog from the Alberta Securities Commission’s CheckFirst.ca.

 

This past year was a standout for financial markets. Stock markets surged, retail trading boomed, and optimism seemed to be the guiding force. In that kind of environment, it’s easy to make investment decisions based on emotion and lose sight of your long-term investment strategy.

 

Achieving your investment goals requires understanding yourself as an investor: knowing your risk tolerance, ensuring your portfolio remains balanced and aligned with your time horizon, and getting the advice you need to make it happen.

 

Knowing the basics of how a balanced portfolio works, why portfolios drift, and what the rebalancing process looks like is essential to keeping you on track towards reaching your goals.

What is portfolio rebalancing?

A balanced portfolio involves allocating investments across different asset classes–such as stocks, bonds, and cash–in ratios that align with your risk tolerance, time horizon, and investment strategy. For example, because younger investors typically want to grow their portfolio and have a higher risk tolerance during their working years, they may prioritize stocks to maximize their growth potential. Investors who are nearing or living in retirement often favour fixed-income investments like bonds to reduce risk and protect the income they earn from their investments.

 

Over time, market fluctuations, sector performance, global events, and other trends can cause this allocation to drift away from the target asset mix and risk level that you started with. This occurrence is called portfolio drift.

 

Rebalancing your portfolio restores your portfolio to the original asset allocation. This process involves buying or selling assets to bring your investments back to their target balance. Think of rebalancing as a routine check-up for your investments–similar to steering a car back on course after a slight deviation. By sitting down with your investment advisor to review and adjust your investments regularly, you can ensure your portfolio stays on track towards reaching your financial goals.

Why does portfolio drift happen?

There are several factors that contribute to portfolio drift:

• Market performance: As of 2024, the TSX has grown by 21.54 per cent. For Canadians with TSX-focused investment funds or stocks in their portfolios, this surge might mean that the overall value of stocks in their holdings has increased significantly. A portfolio favouring these TSX stocks could yield higher returns, but it also exposes you to greater market volatility. Remember, a deviation from your original asset mix and risk level could leave you vulnerable to sudden drops in the market.
• Seasonal trends: Short-term events can also change your portfolio’s balance. For example, the Santa Claus Rally, where stock prices often rise during the last week of December, or the January Effect, where stocks tend to perform well at the start of a new year, could also impact your asset allocation.
• Political and economic events: Political or economic changes can have a big impact on the markets and, in turn, on your portfolio. For example, the outcome of the 2024 U.S. election has caused the U.S. stock markets to surge and interest in alternative investments like crypto to increase significantly. While these changes may offer growth opportunities, they also introduce risks tied to global trade, increased speculative trading, regulatory changes, and market uncertainty.

Why should you rebalance your investment portfolio?

By routinely rebalancing, you ensure your portfolio is well-diversified, which is a cornerstone of a sound investing strategy.

 

Monitoring your portfolio becomes especially vital during significant swings in the market. According to Vanguard’s 2020 study entitled “The Value of Advice: Addressing the Role of Emotions,” investors with clear financial goals were more likely to stick to their strategies during turbulent times instead of letting emotion drive them off course. The research showed that following a plan reinforced long-term thinking and helped investors avoid making decisions out of FOMO (fear of missing out).

How and when should you rebalance your portfolio?

Deciding when to rebalance is just as important as the rebalancing process itself. Studies show that a planned approach to monitoring investments reduces the risk of over-concentration in a single asset or sector. Here are three common approaches:

• Calendar rebalancing: This approach involves reviewing your portfolio allocation at regular intervals (i.e. quarterly, semi-annually, or annually). However, one critical aspect to remember is that rebalancing too frequently or too infrequently can cause issues. Rebalancing too often may result in higher transaction costs and larger tax implications, especially in taxable investment accounts. But rebalancing too infrequently can cause your portfolio to drift too far from the target allocation over time.
• Threshold-based rebalancing: This method is commonly used by asset managers. It allows your portfolio allocation to drift within a certain threshold. Rebalancing will only occur when the value in your portfolio exceeds this range. For example, if you want equities to make up 55 per cent of your portfolio, the threshold-based approach would require rebalancing if the equity allocation exceeds 50 per cent or falls below 60 per cent. This method requires frequent monitoring, so it works best when you partner with an investment team.
• Hybrid rebalancing: Hybrid combines the calendar-based and the threshold-based approaches. Asset allocation weights are checked regularly, but changes are only made if your investments have drifted beyond your target percentages by a certain amount.

Successful investing isn’t about timing the market perfectly or chasing market trends. It’s about getting the advice you need to make informed, disciplined decisions that align with your financial objectives. By regularly sitting down with your advisor to discuss your investments and to rebalance when necessary, you can be confident that you’re setting yourself up to make your goals a reality.

 

Learn more about structuring your portfolio for success at our upcoming seminar. You can register by clicking here.