How do you rebalance a portfolio?

In March 2020, the stock markets fell due to the lockdown announced in several economies as a result of Covid-19 beginning to spread. While it is important to diversify your portfolio, you should also monitor it and rebalance it regularly, to maintain your target asset allocation. Rebalancing is done by buying and selling securities in your portfolio to maintain the same proportions for each security or each class of assets.

Why rebalance your portfolio?

Every investor is unique and has different financial goals. While some people tolerate the risks inherent in the markets, others prefer having a portfolio with minimal risk. When building a portfolio, the funds will be distributed among different asset classes, each of which has a target weighting. For example, your target weighting for the “Canadian Equities” class could be 20%.

In the case of an exchange-traded fund (ETF) portfolio, each asset class may be represented by a single ETF, although not necessarily. In the case of a portfolio consisting of stocks and bonds, however, each asset class will be comprised of several securities, which must also maintain a certain weight. To use our example again, the “Canadian Equities” asset class of a portfolio could be made up of five different stocks, each with a 4% weighting. Portfolio rebalancing, therefore, consists of ensuring that each asset class, or even each security, maintains the same weight over time.

Another benefit of portfolio rebalancing is that it forces investors to sell stocks that have gained the most and buy back those that have fallen the most. It is therefore a mechanism that partially protects the investor against stock market cycles, by going against the grain of market trends.

When should you rebalance your portfolio?

There are several reasons why you may want to rebalance your portfolio.

First of all, it can be related to market fluctuations. If the market is experiencing strong rises or falls, it’s possible that the assets in your portfolio no longer meet your investment strategy and therefore require rebalancing. Generally, beyond a variation threshold of 5% to 10%, it’s advisable to rebalance your portfolio. For example, if you have a portfolio made up of 50% equities and 50% bonds, with a deviance threshold of 5%, you’ll have to consider rebalancing your portfolio if the markets fall in such a way that the percentage of equities in your portfolio drops below 45%.

Another approach is to rebalance at regular intervals. Generally, it’s advisable to do this every six or twelve months to maintain a portfolio that meets your investment strategy criteria as much as possible.

If your investment strategy changes, you’ll also need to readjust your portfolio. By deciding to take more or less risk, your current portfolio will no longer be adequate and will therefore require rebalancing.

However, you must be careful not to rebalance too often because of the transaction costs that this can generate.

How do you rebalance a portfolio?

The principle of rebalancing is based on a simple principle: sell the assets that have experienced an increase and purchase assets that have suffered a decline. The advantage of such a strategy is to ensure that a certain category of assets does not occupy too much weight in the portfolio. By rebalancing your portfolio, you better manage your risk and maintain your diversification, while ensuring that part of the capital gains realized in your portfolio is crystallized. You can also build your own robo–advisor by following these steps.