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How (And When) To Rebalance Your Portfolio

Setting up the initial asset allocation for your investment portfolio is fairly straightforward. The challenge is knowing how and when to rebalance your portfolio.

Let’s say you’re an index investor like me and use one of the Canadian Couch Potato’s model portfolios – TD’s e-Series funds. An initial investment of $50,000 might have a target asset allocation that looks something like this:

Fund Value $ Allocation % Change %
Canadian Index 12,500 25
U.S. Index 12,500 25
International Index 12,500 25
Canadian Bond Index 12,500 25

The key to maintaining this target asset allocation is to periodically rebalance your portfolio. Why? Because your well-constructed portfolio will quickly get out of alignment as you add new money to your investments and as individual funds start to fluctuate with the movements of the market.

Indeed, different asset classes produce different returns over time, so naturally your portfolio’s asset allocation changes. At the end of one year, it wouldn’t be surprising to see your nice, clean four-fund portfolio look more like this:

Fund Value $ Allocation % Change %
Canadian Index 11,680 21.5 (6.6)
U.S. Index 15,625 28.9 +25.0
International Index 14,187 26.2 +13.5
Canadian Bond Index 12,725 23.4 +1.8

Do you see how each of the funds has drifted away from its initial asset allocation? Now you need a rebalancing strategy to get your portfolio back into alignment.

How And When To Rebalance Your Portfolio

Rebalance your portfolio by date or by threshold?

Some investors like to rebalance according to a calendar: making monthly, quarterly, or annual adjustments. Other investors prefer to rebalance whenever an investment exceeds (or drops below) a specific threshold. In our example, that could mean when one of the funds dips below 20 percent, or rises above 30 percent of the portfolio’s overall asset allocation.

Don’t overdo it. There is no optimal frequency or threshold when selecting a rebalancing strategy. However, you can’t reasonably expect to keep your portfolio in exact alignment with your target asset allocation at all times. Rebalance your portfolio too often and your costs increase (commissions, taxes, time) without any of the corresponding benefits.

According to research by Vanguard, annual or semi-annual monitoring with rebalancing at 5 percent thresholds is likely to produce a reasonable balance between controlling risk and minimizing costs for most investors.

Rebalance by adding new money

One other consideration is when you’re adding new money to your portfolio on a regular basis. For me, since I’m in the accumulation phase and investing regularly, I simply add new money to the fund that’s lagging behind its target asset allocation.

For instance, our kids’ RESP money is invested in three TD e-Series funds. Each month I contribute $416.66 into the RESP portfolio and then I need to decide how to allocate it – which fund gets the money?

Rebalance your TD e-Series portfolio

My target asset allocation is to have one-third in each of the Canadian, U.S., and International index funds. As you can see, I’ve done a really good job keeping this portfolio’s asset allocation in-line. How? I always add new money to the fund that’s lagging behind in market value. So my next $416.66 contribution will likely go into the International index fund.

It’s interesting to note that the U.S. index fund has the lowest book value and least number of units held. I haven’t had to add much new money to this fund because the U.S. market has been on fire; increasing 40 percent since I’ve held it, versus 18 and 13 percent respectively for the International and Canadian index funds.

One big household investment portfolio

Wouldn’t all this asset allocation business be easier if we only had one investment portfolio to manage? Unfortunately, many of us are dealing with multiple accounts, from RRSPs, to TFSAs, and even non-registered accounts. Some also have locked-in retirement accounts from previous jobs with investments that need to be managed.

The best advice with respect to asset allocation across multiple investment accounts is to treat your accounts as one big household portfolio. That’s easier said than done if you’ve got multiple accounts held at various banks and investment firms. The objective, though, is to not have to duplicate the same portfolio across multiple accounts.

My investment accounts are limited to my RRSP and TFSA, and I use a two-ETF portfolio, which makes asset allocation super simple to manage. My target asset allocation is 20-25 percent Canadian equities and 75-80 percent International equities.

Combined, I have approximately $170,000 invested in my RRSP and TFSA accounts. My RRSP is substantially larger than my TFSA at this point, but I’m adding new money to my TFSA at a higher and more frequent rate. I hold mostly International equities in my RRSP and Canadian equities in my TFSA.

Fund Value $ Allocation % Account
VXC (All World ex Canada) 130,900 77.0 RRSP
VCN (Canadian) 22,500 13.2 RRSP
VCN (Canadian) 16,600 9.8 TFSA

New TFSA contributions of course go into VCN while any RRSP contributions go into VXC. At some point soon Canadian equities will start to make up more than 25 percent of my portfolio and so I’ll be forced to sell some units of VCN in my RRSP and purchase more units of VXC to bring my target asset allocation back into alignment.

Final thoughts

Your original target asset allocation is the most important decision when it comes to building your portfolio. Over time, as your investments yield different returns, your portfolio drifts away from that initial target, exposing it to risks that might not be compatible with your goals.

Rebalancing your portfolio reduces that risk exposure and increases the likelihood of achieving your desired long-term investment returns. The other benefit of a rebalancing strategy is that it forces you to buy low (i.e. the lagging fund) and sell high (or at least avoid buying as much of the high-performing fund).

Do you have a question about rebalancing your portfolio? Ask away in the comments below:

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8 Comments

  1. Kenton Ehgoetz on October 10, 2017 at 5:40 am

    Should I also sell my worst preforming funds and buy more of the best funds at this time?
    How long should I keep a under performing fund before I remove it from my portfolio ?

    • Brad S on October 24, 2017 at 12:28 pm

      If I may… Based on my understanding of this process, the point is in fact to buy into the lowest performing funds at the time of rebalancing (or when making periodic contributions). Granted, there might be cause to evaluate an individual investment and change to something else but you should not be investment hopping.

    • Cristian on October 24, 2017 at 5:18 pm

      That is the best way to sell cheap stuff and buy expensive one. Balancing means exactly the opposite, selling part of the performing ones to bring them back to initial allocation and buy more of the ones that have underperformed.

  2. Owen @ PlanEasy.ca on October 10, 2017 at 7:11 am

    This is all really solid advice.

    We also use the 5% thresholds based on the Vanguard study. We do this once every 4 months and we treat most of our accounts as one big portfolio since they’re for the same purpose (retirement). Only our RESP has a slightly different allocation.

    Normally we can re-balance with contributions but we have had to re-balance by selling a couple of times over the last 10+ years.

    All in all its a pretty easy way to manage a portfolio.

  3. Michael James on October 10, 2017 at 7:14 am

    Something to consider when treating RRSPs and TFSAs as a single portfolio is that RRSPs aren’t really all your money. If you expect to be paying about 25% tax on RRSP withdrawals, then you should discount your RRSPs by 25% before adding them to your TFSAs to compute your asset allocation.

    • Lise on November 1, 2017 at 6:58 am

      Interesting point – – I have never heard this considered before but it makes sense.

  4. Bob Baker on November 1, 2017 at 10:28 am

    Food for thought:
    1) There is a difference between investing while saving (adding money) and while retired ( withdrawing money) . Dollar cost averaging one way, reverse (negative) dollar cost averaging in the other.
    2) Basic asset allocation of the overall portfolio is a risk management effort tailored to suit your comfort for loss. The problem- if you lack the triple “Ts”- time, temperament, talent then your comfort will be low. This means, if your young, your portfolio will be too conservative.(ouch). If your advisor, assuming you then have one, risks his/her professional liability to take you higher. A quandry for both!
    As markets have moved from March 2009 ( the low) to now ( the high or overvaluation) obviously the risk in the market has changed. How does one recognize these two extremes in setting overall asset allocation then and now? Basically more risk assets in 2009 and less now. For me, I want to be prepared to avoid the big losses and be set to exploit the opportunity when loss (valuations fall). Few people recognize how to judge this, both as investors and as advisors. Inherently, investment management (professionals) are supposed to do this – but most are managing a specific asset, not asset allocated portfolios. So where does one go – diy, robo-advisor, a advisor/mgr combo, a portfolio manager( ( they have fuduciary responsibility)?? Whose at fault? One,the other, or all, you me included? Your thoughts?

  5. C on October 28, 2018 at 12:17 pm

    Thanks for the post! The lazy side of me would like to know if you or anyone else has any suggestions for an easy software/tool to help you track your investments and tells you how much to buy/sell when you’re rebalancing or do you just bust out some good ol’ fashion math and time?

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