Why Rebalance Your Portfolio Asset Allocation?

by Mike Holman

The Canadian Capitalist recently wrote about couch potato investing and Sampson left some interesting comments about rebalancing and passive investors. 

 Here are a few thoughts I have about portfolio rebalancing:

 1) The main reason I rebalance is to maintain a consistent risk level in my portfolio.  For example if I decide I want a portfolio made up of 60% equities and 40% bonds and then after a couple of years, the portfolio is 70% equities and 30% bonds, my portfolio is now riskier than I planned and I will want to rebalance back to 60% equities and 40% bonds.

 2) Asset allocation is not something that just couch potato investors do – every investor has an asset allocation and likely rebalances.  Of course if you have 100% equities, your asset allocation never changes, so no rebalancing is required.

 3) I’m not a believer that rebalancing (in any form) will increase returns significantly or at all.  It really depends on the market activity and an assumption that asset classes will “revert” to the mean. In some markets it will help – in other markets it will hinder.

 4) Rebalancing assumes that your different asset classes are not correlated.  In my case, I use a short term bond ETF for my fixed income – I’m fairly certain that short term Canadian bonds are not very correlated with various world equities. Even if they were, my asset allocation would never change much and I would have no need to rebalance

 5) Rebalancing can take many forms including tactical asset allocation.  The reason a lot of people like to use a specific rebalancing rule is because it makes things easier. I don’t have a firm rebalancing rule, but I will try to check my portfolio once a year and if the allocations are significantly out of what, I’ll rebalance.

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