The benefits of re-balancing

Diversifying your portfolioPortfolio All the different investments that an individual or organization holds. May include stocks, bonds and mutual funds.+ read full definition with a mix of assets, like stocks and bonds, is a good way to lower risk and smooth out returns, but it’s not something you can just ‘set and forget.’

Over time, your asset mix will shift as your holdingsHoldings Shares or other interests in a business. Also refers to investments in a portfolio.+ read full definition gain or lose value. Re-balancing your portfolio from time to time – either by yourself or with your financial advisor – is part of the regular maintenance you need to do to keep your asset mixAsset mix The percentage distribution of assets in a portfolio among the three major asset classes: cash and cash equivalents, fixed income and equities.+ read full definition close to your financial planFinancial plan Your financial plan should cover every aspect of your finances: saving and investing, paying down debt, insurance, taxes, retirement planning and estate planning.+ read full definition and on track with your goals.

Re-balancing your asset mix

A diversified portfolio will hold a mix of different assets like stocks and bonds. You can diversify these holdings even further by investing across various sectors and seeking opportunities outside of Canada. When you set up your portfolio, these different assetAsset Something of value that a company or an individual owns or controls. Examples: buildings, equipment, property, a car, investments, or cash. Can also include patents, trademarks and other forms of intellectual property.+ read full definition classes make up a predetermined portion of your holdings. The asset mix that makes sense for you will depend on your objectives, time horizonTime horizon The length of time that you plan to hold an investment before you sell it. This may be a brief period of time or span as long as decades, depending on your financial goals.+ read full definition and risk tolerance.

The investmentInvestment An item of value you buy to get income or to grow in value.+ read full definition mix within your portfolio will change as the value of your holdings go up and down with the markets. As this happens, the holdings that are doing well will accountAccount An agreement you make with a financial institution to handle your money. You can set up an account for depositing and withdrawing, earning interest, borrowing, investing, etc.+ read full definition for a larger shareShare A piece of ownership in a company. A share does not give you direct control over the company’s daily operations. But it does let you get a share of profits if the company pays dividends.+ read full definition of your portfolio. While this may sound positive, it may not support your goals over the long termTerm The period of time that a contract covers. Also, the period of time that an investment pays a set rate of interest.+ read full definition because it could increase the risk of your portfolio. Re-balancing will help to bring your risk back in line.

For example, let’s say you start with a portfolio that was 60% equitiesEquities Another word for investments in the stock market.+ read full definition and 40% bonds. If equities increase in value and bonds remain relatively unchanged, the asset mix in your portfolio could be closer to 70% equities and 30% bonds at the end of the year. If unchanged, one asset – or possibly a single company or fund – could have an outsized impact on your performance. Re-balancing will also help lower volatilityVolatility The rate at which the price of a security increases or decreases for a given set of returns. A stock price that changes quickly and by a lot is more volatile. Volatility can be measured using standard deviation and beta.+ read full definition and smooth out your returns.

Restoring your portfolio weightings to your original plan will allow you to maintain the benefits of diversificationDiversification A way of spreading investment risk by by choosing a mix of investments. The idea is that some investments will do well at times when others are not.+ read full definition.

How to re-balance

There are two common ways to re-balance your portfolio. If you regularly add funds to your portfolio, you can use that as an opportunity to restore your asset mix to your original ratio.

For instance, if the bondBond A kind of loan you make to the government or a company. They use the money to run their operations. In turn, you get back a set amount of interest once or twice a year. If you hold bonds until the maturity date, you will get all your money back as well. If you sell…+ read full definition portion of your portfolio falls behind your plan, you would direct those new funds to that part of your portfolio to restore the balance. If you are contributing new money to your portfolio and the asset mix is already balanced, you’d simply distribute those funds according to your plan.

If you are not able to investInvest To use money for the purpose of making more money by making an investment. Often involves risk.+ read full definition money to re-balance your portfolio, you can restore your asset mix by selling some investments and redistributing those funds. With this approach, you would sell your investments from the asset classAsset class A group of securities that have similar characteristics. Examples of asset classes include, such as stocks, bonds, real estate or cash.+ read full definition that has a higher weight in the portfolio and re-direct those funds to the other assets in your portfolio until you restore the balance.

While some investors may find it hard to sell their best-performing investments, this discipline will help you lock-in gains on your best-performing investments. It will also ensure you’re directing those funds to assets that may be undervalued, lowering the risk that you’re going to overpay. If you decide to sell, always take into account the fees associated with the transactionTransaction The process where one person or party buys goods or services from another for money. Examples include taking money out of an account, buying something with a credit card or taking out a loan.+ read full definition as well.

Re-balancing frequency

While your asset mix will always be in a state of flux, you don’t have to react every time your portfolio drifts from your plan. Re-balancing frequently can also increase costs associated with buying and selling investments.

For many investors, re-balancing once or twice a year should be sufficient. Try to re-balance at the same time each year; this has the added benefitBenefit Money, goods, or services that you get from your workplace or from a government program such as the Canada Pension Plan.+ read full definition of helping you control emotions that can influence your decisions.

Diversification is an effective way to lower your investment risk, but it is only effective if you actively re-balance your portfolio.

Take action

  1. Pick a memorable date like a birthday to remind yourself to re-balance your portfolio
  2. If you are adding money to your portfolio, try using those funds to re-balance first

When re-balancing, selling investments that have climbed the most will help you lock-in your gains and reduce the overall risk of your portfolio

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