In this special Q & A, we asked Tony Mahabir, CEO of Canfin Financial Group of Companies, about the key things to consider when rebalancing a portfolio.
How important a role does portfolio rebalancing play?
To a casual investor rebalancing a portfolio, or realigning the weightings of assets, may seem trivial, or one of those distant “when I get around to it” things, but it shouldn’t be. Rebalancing one’s portfolio is a vital component to a winning investment strategy.
When developing a rebalancing strategy, the considerations are always “how often, how far, and how much”. By regularly monitoring a portfolio one can determine how far an asset allocation should be allowed to stray from its target before it is rebalanced, and whether periodic rebalancing should restore a portfolio to its target or to a close approximation of the target. The goal of portfolio rebalancing is in minimizing risk relative to a target asset allocation, rather than maximizing returns.
While investing for the long term requires patience, a disciplined and strategic approach to rebalancing can help create value beyond the recurring trends of the market.
When should a portfolio be rebalanced?
The rule of thumb is to review and rebalance annually or semi-annually, especially if the risk profile or the asset class weighting of the portfolio has changed by five to ten percentage points. When one piece of pie goes up, it could be easy to let greed lead, but fight the urge and take profits from winners from time to time.
As an example, let's say an allocation in small-cap stocks (companies classified as small market capitalization with capitalization between $300 million to $2 billion) rises from 15% to 20%. If the small-cap holdings are not cut back to 15% target allocation, the risks in the investments are increased. In other words, if small-caps suddenly start falling, 20% of the portfolio will drop with them rather than 15%.
Inversely, if distribution in international stocks has dropped from 20% to 15%, it’s an indicator that prices have dropped thereby presenting a buying opportunity. The old adage, “buy low, sell high” will never go out of favour. For anyone feeling uncomfortable researching areas of the market, investment professionals stand ready to assist.
No one wants their portfolio to drift from Growth and Income to Growth OR Income.
Can one re-balance too often?
If asset allocations have not drifted far from target allocations, one might ask whether it makes sense to incur transaction costs and potential tax liabilities to bring that back in line? The simple answer is no.
Tax implications (non-sheltered accounts, non-RRSPs) are one of the biggest downsides for lost dividend distributions if paid quarterly or monthly. Ill-timed rebalancing done in an undisciplined manner could end up harming the portfolio and missing dividend payments.
What's the worst mistake an investor can make?
Except in the face of life changes, staying on course is paramount. Some investors stray from their original plan due to lack of discipline or they get emotionally attached to their “winners” and hold a grudge against their “losers”. Taking from the winners to reward losers is counter intuitive to investor psychology, but often times a must.
Investors, big and small, have the urge to thrust money into "hot" stocks as they conjure up future treasures. For those that tend to get swept up with market euphoria or panic in a market downturn, there are words of wisdom: The only thing certain is that markets go up and markets go down, yet there is no identifiable pattern year over year. Think long-term, big-picture.
Looking beyond Canada for investment opportunities
A portfolio manager's tips