Financial markets have experienced volatility in recent months as investors mull over positive economic news, mixed corporate earnings, heightened international tensions, and the prospect of a more hawkish U.S. Federal Reserve Board. While volatility can be unnerving, it reminds us of the importance of portfolio diversification in spreading out the potential for risk across multiple industries, regions, and even company sizes.
 

Volatility can throw off an investment portfolio’s long-term strategic asset allocation—the mix of asset classes, such as equities and fixed income, that’s consistent with your long-term goals and objectives. For example, if volatility causes the equities in your portfolio to decline in value and the fixed income to rise in value, then the mix would change to a lower percentage of equities and a higher percentage of fixed income.
 

This is where portfolio rebalancing plays a role. Rebalancing aims to return your portfolio to its strategic asset mix. The strategic mix has a long-term focus and aims to ensure your portfolio maximizes the opportunity to achieve its investment goals in a manner consistent with your risk profile.
 

The need to rebalance portfolios primarily arises from market developments. Asset prices change through time. Some markets go up or down more than others during a particular period. Price changes can cause portfolios to drift away from their strategic asset mix. This drift can introduce unintended risks into portfolios, such as higher asset concentrations caused by a growing proportion of the portfolio in a certain asset class. This could cause higher portfolio volatility in future.
 

Rebalancing is a disciplined way to maintain risk and diversification within an acceptable range. Rebalancing involves periodically selling assets that have recently outperformed and buying assets that have underperformed.
 

In any period, we never know how far prices might drift from their underlying valuation, making it impossible to set an optimal rebalancing schedule. Instead, investors typically follow one of the following two approaches to rebalancing:
 

1. Regular calendar basis—quarterly or annual rebalancing.
 

2. Threshold basis—rebalancing whenever the asset mix drifts away from strategic weights by more than a predefined percentage. For instance, when the equity weighting in a traditional 60/40 portfolio (i.e. 60% equity, 40% fixed income) moves outside of a 55-65% range, rebalancing guidelines would trigger a portfolio rebalancing. Some measure of portfolio tracking error can also be used as the threshold in this approach.
 

Our team is dedicated to assisting you to rebalance your portfolio regularly so that it aligns with your investment goals and risk profile. As always, please feel free to contact us if you have any concerns or questions.