How to Lower Your Rebalancing Costs

Last week I looked at why you should rebalance your portfolio, and considered the question of how often to do it. The frequency with which you rebalance often comes down to cost. If you’re using index mutual funds in a registered account, the cost may be zero. But if you’re paying ETF trading commissions or incurring capital gains taxes when you rebalance, then you should consider strategies to keep your costs as low as possible.

Here are three ideas for lowering your rebalancing costs. And at the bottom of this post, I’ve also included a rebalancing spreadsheet that you can download and adapt for your own portfolio.

Do it less often

I recently heard from an investor who put $10,000 in the Global Couch Potato four years ago, using iShares ETFs. He said he religiously rebalanced the portfolio once a year—at $29 per trade. That means trading commissions eroded about 1% of his portfolio’s value annually. Any advantage that rebalancing might have given this investor would likely have been wiped out by that excessive cost.

If you have a small ETF portfolio, keep rebalancing to a minimum, especially if you are paying high brokerage commissions. Unless your portfolio is way out of whack, there is no pressing need to rebalance annually—every second year is fine.

Focus on the broad stock-bond mix

Your overall blend of fixed income and equities has the greatest influence on your portfolio’s volatility. The rest is just details, so don’t obsess over them. For example, let’s say your target is 30% bonds and 70% stocks, divided as follows: 20% Canadian, 20% US, 20% international and 10% emerging markets. A year later, you find yourself with 24% Canadian, 19% US, 18% international and 11% emerging markets, for a total of 72% equities.

You probably don’t even need to rebalance this portfolio at all, because your overall stock-bond mix has barely changed. If you feel you must, you can simply trim 2% from the Canadian equity fund and putting it into bonds. Making any additional trades would just be a waste of money.

Mix mutual funds and ETFs

While index mutual funds generally have higher annual fees than ETFs, they do have one big advantage: you can add or withdraw small amounts of money without cost. Even if you’re primarily an ETF investor, consider keeping one or more of your holdings in index funds to help lower rebalancing costs. If your broker is TD Waterhouse, for example, consider using e-Series funds for your core holdings and ETFs for emerging markets, REITs and other asset classes that those funds do not cover.

In my own RRSP, I actually use the PH&N Inflation-Linked Bond Fund rather than an ETF for my allocation to real return bonds. (Yes, it’s actively managed, but it costs 0.55% and its holdings are almost identical to the index ETFs.) As equities have outpaced bonds over the last two years, I have kept my allocation to fixed income in balance by adding new money to this fund, including the cash dividends paid out by my ETFs. This has allowed me to keep my overall stock-bond mix consistent without incurring any trading commissions.

A handy rebalancing spreadsheet

Confused by the math involved in rebalancing your portfolio? I’ve created a handy rebalancing spreadsheet, which you can download here. Here’s how to use it effectively:

• In column A, enter the names of the index funds or ETFs in your portfolio. I’ve included room for multiple asset classes: you can add or delete rows as necessary.

• In column B, enter the target allocation you’ve set for each of your asset classes.

• In column C, enter the current value of each of your funds. The spreadsheet will calculate what percentage of your portfolio each fund represents and display this in column D.

• When you’re ready to rebalance, enter the amount of new money you’re adding in cell B9. (If you plan to rebalance without adding any new money, enter $0.01.)

• The spreadsheet will then calculate how much money you need to add or subtract from each fund in order to perfectly rebalance the portfolio. These values will appear in column E.

Hope you find the spreadsheet useful. Please let me know if you have any suggestions for improving it.