“Do I really need to rebalance my investment portfolio?”

Photo by Milada Vigerova on Unsplash

Q. I have been investing the Couch Potato way for several years now, and I love it because it’s such a simple strategy. Still, I am very negligent when it comes to rebalancing. It’s now been six years since I’ve rebalanced my RRSP and TFSA, but my returns have still been very good. What returns can I expect going forward if I never rebalance my asset allocation? Would it make that big of a difference to returns over 30 years? I’d really like to avoid having to rebalance if possible. What do you suggest? –Nick A. The very name of the Couch Potato strategy suggests that it thrives on sloth and neglect. And there’s some truth to this: Tinkering with a well-diversified portfolio is likely to sabotage your returns rather than improve them. And shifting your asset allocation based on market forecasts is also prone to backfire. That’s why it’s best to simply design your portfolio thoughtfully, and then largely leave it alone. But you can take this idea too far. And making a decision to never rebalance is definitely crossing that line. Nick, you mentioned you haven’t rebalanced your portfolio in six years, and yet the returns “have still been very good.” No doubt. In fact, if you have a global portfolio of stocks and bonds, your returns have almost certainly been better than if you had rebalanced annually. Over the last six years (ending June 30), Canadian bonds delivered about 4.1% annually. Meanwhile, Canadian and international stocks delivered returns in the neighbourhood of 8% to 9%, while the U.S. outshined them all with annualized gains of more than 16%. So during that period, rebalancing would mostly have consisted of selling stocks that had recently performed well and then buying bonds which went on to deliver more modest returns. By never touching your portfolio, you would have enjoyed better performance than an investor who diligently rebalanced once a year or so. But as I explained in a recent column, the goal of rebalancing is not to improve your returns. Its primary objective is to control risk. Presumably when you set up your portfolio six years ago you decided on an appropriate asset allocation. Let’s assume this was a classic blend of 40% bonds, 20% Canadian stocks, 20% U.S. stocks, and 20% international stocks. Because the returns of these four asset classes varied significantly, your mix would be much different now: your bond allocation would have declined to about 30%, whereas U.S. equities have probably climbed to about 30%.

Compare the Best Robo-Advisors in Canada* >

That’s quite a different portfolio from the one you designed six years ago: With less fixed income, it’s riskier overall. If you were to continue this pattern for 30 years, the problem would likely keep compounding, and your portfolio would get increasingly aggressive. We haven’t experienced a significant bear market in the last half-dozen years, but at some point, we will. And if by then you have a much higher allocation to stocks, the losses you suffer in the next downturn will be greater than you anticipated. The good news is that Couch Potato investors who shun spreadsheets have better options than they did in the past. The three largest providers of exchange-traded funds (ETFs) in Canada— Vanguard, iShares and BMO—have all recently launched families of “asset allocation ETFs” that do all the work for you. Each one holds a globally diversified portfolio of stocks and bonds with a target asset mix: these can range from conservative portfolios with only 20% stocks, to aggressive ones with 80% stocks. The fund manager will maintain the portfolio to keep it very close to its long-term targets, so investors get the best of both worlds: the risk management that comes with regular rebalancing, and the convenience of never having to make any of their own trades (except when adding new money). Nick, I would suggest you consider using one of these single-ETF portfolios. Just pick the one that most closely matches your risk profile, then liquidate your existing holdings and replace them with this simple solution. Because you’re investing in a TFSA and an RRSP, there will be no tax consequences, and the small number of trading commissions will be worth it in the long run. You can probably complete this makeover in about 30 minutes, and then you can safely go back to ignoring your portfolio and letting the markets do all the work. Dan Bortolotti, CFP, CIM, is a portfolio manager and financial planner with PWL Capital in Toronto.

Compare the Best Online Brokers in Canada* >

MORE BY DAN BORTOLOTTI:

What does the * mean?

Affiliate (monetized) links can sometimes result in a payment to MoneySense (owned by Ratehub Inc.), which helps our website stay free to our users. If a link has an asterisk (*) or is labelled as “Featured,” it is an affiliate link. If a link is labelled as “Sponsored,” it is a paid placement, which may or may not have an affiliate link. Our editorial content will never be influenced by these links. We are committed to looking at all available products in the market. Where a product ranks in our article, and whether or not it’s included in the first place, is never driven by compensation. For more details, read our MoneySense Monetization policy.

Comments Cancel reply

Kelly B says:

September 30, 2020 at 10:05 am

What does it mean to rebalance your portfolio?

I understand the general concept but if I am doing a 40/20/20/20 split, meaning I put 40% of my money in bonds and 20% of my money into each of the other 3, what is there to rebalance?

I am just about to start investing and am planning on doing $350 a week, with the percentage split above between the 4 recommended TD mutual funds (since I want to deposit regularly). Wouldn’t I just keep investing at that ratio (while adjusting a little more towards bonds as I age) or am I missing something? Do the ratios not refer to the money you put in or is it something else?

Reply
1. Sandra E. Martin says:
  
  September 30, 2020 at 3:26 pm
  
  Hi Kelly,
  Over time, the proportions you originally allocated to bonds, equities and cash (for instance) will shift. If your Canadian stocks appreciated in value, you would then be overweight in Canadian holdings, as an example. So you need to sell off some holdings to bring your portfolio back to the intended 40/20/20/20. Make sense? This is a topic we’ve covered fairly often over the years, so please do browse the site for more information.
  
  Reply