In 10 basic truths about investing, Sarah Riopelle, Vice-President and Senior Portfolio Manager, RBC Global Asset Management, lists asset allocation as one of the most important parts of investing. Asset allocation refers to the ‘weighting’ of different asset classes within your portfolio. When building a portfolio, you can choose a mix of investments from different asset classes: cash and cash equivalents, fixed income and equities, for example. You set the portion or “weight” of each type of investment based on your investor profile and tolerance for risk.
Here’s a sample asset allocation for an investor. Notice they have just 40% of their portfolio invested in equities. For more growth-oriented investors, who can tolerate more risk, that number would be higher.
Market impact on your asset allocation
Market fluctuations can change the value of your investments. Let’s say the equities in that portfolio grow 10% in value over the course of two years. That portfolio is now starting to take on more of a growth-oriented profile.
This change over time is called portfolio drift. It can happen to every investor. Why is it a concern? It can expose you to more risk or less growth than you originally planned. In other words, you’re no longer tracking to your original plan. By rebalancing your portfolio you can correct the drift, and return to your original asset mix. Here’s how it works.
Canadian equities: S&P/TSX Composite Total Return Index. Fixed income: FTSE Canada Universe Bond Index. U.S. equities: S&P 500 Total Return Index.
All performance in C$.
Source: RBC Global Asset Management.
Review the original weights you set for your asset allocation. Then, to bring your portfolio back into balance, you can:
- Invest additional funds in any asset class that is underweight.
- Sell investments from any asset class that is overweight to free up cash. Then buy investments in any asset class that is underweight.
When to rebalance your portfolio
- The 5% rule: This ‘rule’ suggests that investors rebalance when any part of your portfolio drifts beyond 5% of its target range. For example, if equities are meant to comprise 40% of your portfolio, you consider rebalancing if they exceed 45% or fall below 35%.
- Tax-loss selling: If you have a taxable investment account (not an RRSP or other registered account), you may want to rebalance near the end of the year. This allows you to use any losses to offset your gains, which can reduce the taxes owed.
- Regular reviews: Annually, monthly or quarterly – the timing depends on you and market conditions. If markets are changing a lot, you may need to rebalance more often.
Mind the costs
Rebalancing basically involves buying and selling investments. This may result in sales fees. Also, in taxable non-registered accounts, the transactions may trigger a taxable event.
Tips to make rebalancing simpler
- Dollar cost averaging: This is where you invest on a regular basis, across all market conditions. You can direct each new investment to help rebalance your portfolio as needed.
- Professionally managed portfolios: This is a turn-key solution where your asset mix is managed by professional portfolio managers. You choose the type of portfolio that’s right for you and they will correct for drift when necessary.
- Work with an advisor: Partner with a professional investment advisor to help you determine an asset mix that’s right for you. They can monitor your portfolio to help you stay on track.
Remember: reassess your investment plan if your investment goals, time horizon or risk tolerance change. And sometimes, changes in markets may also prompt you to review and rebalance. Staying informed about the markets and the economy can help you monitor your portfolio drift and determine if and when action is necessary.