The consequences of not rebalancing
If you think about not rebalancing your wheels on your car if you’re not actively driving the steering wheel, the car sort of veers off to one side instead of staying straight on the road. If you don’t regularly rebalance your asset allocations in your RRSP and TFSA will be off and you stand to gain less (or even lose money, of course) than if you were to diligently rebalance. Therefore, it makes sense to rebalance regularly, and yet many people (including myself) are hesitant to regularly rebalance. If you write it down or make some rules to rebalance, you will be much more likely to regularly rebalance. Your portfolio will thank you and be grateful.
Here are some ways that you might want to adopt for your investing practice that might give the portfolio some namaste and good karma:
Rebalance according to scheduled times
Some people rebalance once a year, twice a year, or four times a year. Some people pick a date or certain months of the year and rebalance in those times. One thing to consider if you’re doing it more frequently (e.g. four times a year) is the cost of rebalancing, according to Moneysense. For my Questrade account, buying more Exchange-Traded Funds is free (no commissions paid) but selling incurs a trading commission. Therefore it costs me nothing extra when I rebalance because I usually add extra funds.
For me, I am rebalancing my TFSA ETF portfolio every March and September (twice a year) and am planning to rebalance my non-registered ETF portfolios and RRSP portfolio in June and January (twice a year). I don’t mind doing it earlier but when I calculated the asset allocation, the portfolios weren’t off by very much so I didn’t bother rebalancing them.
Rebalance according to deviation from asset allocation
This comes to the next reason how you might want to rebalance your portfolio- according to deviation from your original asset allocation. I was reading Think, Act, and Invest Like Warren Buffett by Larry Swedroe and he recommended that you rebalance when your asset allocation deviates by an absolute 5%. Kevin O’ Leary also recommended this practice in one of his books, I think it was The Cold Hard Truth on Men, Women, and Money.
What does an absolute 5% mean? For example, if you were supposed to have a portfolio that looked like this:
- 25% XDV
- 25% CPD
- 25% CYH
- 25% XTR
and it ends up looking like this after a year:
- 20% XDV
- 26% CPD
- 31% CYH
- 24% XTR
You might want to consider rebalancing because the asset allocation is ‘off’.
But what if I dollar cost average and regularly contribute?
Well, I’m sorry to say that it doesn’t count. In my TD e-series I dollar cost average and contribute monthly. I have been doing this for a few years but never got around to rebalancing. Boy was the original asset allocation off- some were off by 6-7% from the original absolute amount. This was an easy fix though, thankfully. Hopefully, I remember to regularly rebalance on an annual basis.
If you want to read how to rebalance the easy-peasy way and cheap way without having to buy and sell a lot of ETFs or stocks, you can check out my article on how to balance a portfolio or even think about trying out a robo advisor (see our Wealthsimple review for more info) if you’re looking for the easiest possible way to invest and have others rebalance your investments holdings for you.
