Well, we’ve done it! We’ve built an investment portfolio. Time to sit back and relax right? Wrong.
Portfolio construction is the easy part. Much like buying a car, the actual purchase requires extensive research after figuring out what you need, but is generally put into action pretty quick. The difficulty comes with maintenance. Oil changes, inspections and the like. It’s the exact same with an investment portfolio
Part 5 – Rebalancing and Keeping Up With Your Investment Portfolio
The amount of time you need to spend keeping up to date and rebalancing your investment portfolio has a lot to do with the allocation we talked about in part 3. Here’s an extreme, if 100% of your portfolio is GICs, you don’t need to monitor your portfolio at all. You simply wait until they hit maturity and collect your pay.
However, if your portfolio is like mine, which is almost a pure stock portfolio, it takes extensive research and rebalancing to keep in line with your objectives.
This brings us to our next step, which is reviewing your asset allocation.
Review of your current allocations
For simplicity sake, we are going to assume you’ve chosen a 70% stock allocation, and you want to keep it this way.
If you start out with 70% stocks and 30% bonds, the value of your bonds will not change until maturity, assuming you don’t sell them. The value of your stocks however can vary dramatically. Let’s say you start out with $10,000, and you have an excellent year and your stock allocation has increased by 30%.
Stocks: $7000 = 70%
Bonds: $3000 = 30%
After one year:
Stocks: $9100 = 75.2%
Bonds: $3000 = 24.8%
You can see we’ve become a bit off balance. This is a situation where you need to sit down and think about what you need to do. Perhaps you’ve become more confident with your investment knowledge and you are comfortable running that allocation amount to stocks in your portfolio and taking a bit more risk. Or, you may decide you’d like to stick to your plan and keep a 70/30 ratio.
Selling assets to rebalance
You’ve assessed your allocation and determined you need to sell off some of your assets to rebalance. Keep in mind I referred to an excellent year above, but the timeline of these reviews can vary depending on how volatile your portfolio is. You may need to do them every 3 months or even monthly. So how do you go about rebalancing?
Well, your first step in a situation like this should always be to conduct a full review of the holdings within your portfolio. This is a topic for another discussion, and we do have another 5 part guide set aside for this, as stock analysis can get quite extensive.
If you’ve concluded that you have some holdings you’re not particularly proud of anymore, there is the option of selling these assets. The cash obtained from the sale can be used to purchase more bonds and stocks to get you back to your 70/30 balance.
If you find there are no particular stocks you’d like to move on from and you are dead set on your allocation amounts, the next step would be to find stocks you’d be willing to sell a portion of in order to purchase more low risk securities.
Perhaps in your 30% gain for the year, a large chunk of it came from the oil and gas sector. You may figure out your exposure to your industry has gone higher due to increase in share price, so you decide to sell a portion of your stocks from these companies to rebalance both your overall weighting towards specific industries in your portfolio, and use that cash to purchase low risk securities.
Things to keep in mind when rebalancing
In terms of portfolio construction, there is not a single element that will remain static as you move through your investment career. Your age, capital, risk tolerance, and asset allocation will change as you progress. So it’s important to sit down and reassess these figures every single time you balance, and finalize your portfolio based on these numbers.
If you are trading outside of a tax free account, an absolute necessity is a re-balance near tax time. If you’re selling stocks at a loss in order to re-balance, the loss can become a tax write off.
In terms of market volatility, a key time to balance is when the market shifts by a substantial amount in either direction. A large increase in prices can allow you to figure out which stocks are considered overpriced, and you could potentially sell them. The opposite is also true for stocks during a decline. You could sell stocks that are no longer appealing to you, and purchase ones that have been falling for an unjustified reason.