- Portfolio drift occurs when natural shifts in the market change your asset allocation, or the ‘weighting’ of different asset classes within your portfolio.
- This can expose you to more risk than you are comfortable with.
- Portfolio rebalancing helps to get your portfolio back in line with your investment objectives. It can also position your portfolio to take advantage of investment opportunities as they emerge in changing markets.
Portfolio drift occurs when natural shifts in the market change your asset allocation, or the ‘weighting’ of different asset classes within your portfolio. Why does this matter? The make-up (or asset mix) of your portfolio sets the level of risk you take on when you invest. Your asset mix can drift when some investments do well and others not. Over time, your portfolio may no longer align with the level of risk you started with. Let’s look at a couple of scenarios.
What does portfolio drift look like?
Scenario 1: Strong performance in equities
Consider the traditionally balanced portfolio with an asset mix of 60% equities and 40% fixed income. In a period where equities perform well, this mix can shift to 65/35 or even 70/30 if left uncorrected. While it is great to reap these gains, the sizable growth means the overall equity allocation of the portfolio grew, and the allocation to fixed income shrank - leading equities to become a greater proportion of the total portfolio. This kind of drift translates to higher risk exposure.
Scenario 2: Weakness in equities
On the other hand, when equity markets decline, a balanced portfolio can swing the other way, as the underperforming asset class will take up less space of the total portfolio. The chart below illustrates, a balanced investor who started with a 60% equity allocation could have seen it go down to 52% in a matter of weeks if the portfolio were left to drift.
As of April 15, 2020. Model portfolio constructed from Series F funds with the following weights: RBC Canadian Money Market Fund: 1%, RBC Bond Fund: 17%, RBC Global Bond Fund: 5%, RBC Global Corporate Bond Fund: 8%, BlueBay Emerging Markets Corporate Bond Fund: 5%, RBC High Yield Bond Fund: 5%, RBC Canadian Equity Fund: 20%, PH&N US Multi-Style All-Cap Equity Fund: 9%, RBC Global Equity Fund: 26%, RBC Emerging Markets Equity Fund: 4%
- As the equity slice of the portfolio became smaller, the fixed income portion grew larger. As a result, the portfolio became more conservative in nature, no longer aligning with the investors’ risk profile.
- Further, without rebalancing, the investor may have missed opportunities to purchase stocks at lower prices and attractive valuations.
When markets are extremely volatile, asset mixes can come off balance quite quickly. Rebalancing is critical in these types of situations, as it can help bring the portfolio back in line with the investor’s true risk tolerance.
Regularly reviewing and rebalancing your portfolio can help you stay on course and steer you towards your long-term investment goals.