Last time, I wrote about asset allocation, which is primarily about managing risk. It means balancing a higher possible pay-off against a lower risk.  That’s important because generally the higher pay-off investment options tend to carry more risk, while the lower pay-off options tend to be less risky.

A good portfolio includes both types of investments.  It includes equities, which have greater growth potential in order to make sure the portfolio’s value continues to increase.  And it also includes fixed income investments. The latter offer minimal growth – yet they allow us to hedge our bets when the economy goes south, which it has done repeatedly during the last few years.

The key to a well-balanced portfolio is that it matches the degree of risk that you as the investor have decided on in consultation with your financial advisor.

Of course, as the market fluctuates, the percentages of funds in equities vs. those in fixed income investments change as well.  And that’s why I find that rebalancing is so crucial.

In fact, in order to maintain a steadily growing portfolio while maintaining the pre-determined degree of risk, it’s important to rebalance on a regular basis.  Here’s how it works.

Let’s say Jill started with 60% of her funds in equities and 40% in fixed income.  After a good year in the stock market, her portfolio might now have 70% in equities and 30% in fixed income.  Clearly, her portfolio now carries a higher degree of risk.

And that’s where rebalancing comes in.  Approximately once a year, we check her allocation in the various categories, compare them to her target allocation, and make adjustments to bring her portfolio back into alignment with her original risk profile.

In the scenario above, we would sell the excess equities and invest that money in fixed income funds.  And with that, her 60/40 proportion would have been reestablished.

Of course, after a bear market, such as the kind we’ve had in recent years, the percentages would have moved in the reverse direction.  In that case, we would sell fixed income funds and purchase equities to bring her portfolio back into balance.

Part of the principle behind this is to buy low and sell high.  If we purchase equities when prices are low, we’ll get more of them for a set amount of money than if prices were high, and as the equities grow again, the portfolio grows as well.

At the same time, keeping the proportion of fixed income investments at the same level helps maintain the stability of the portfolio.

How often should you rebalance?  I would recommend to do it at least once a year.  Historically, people who rebalance annually tend to build their wealth faster than people who don’t.

It’s also important to rebalance automatically. You can even set up your portfolio do just that without any effort on your part.  Such automatic rebalancing takes your emotions out of the equation – and that’s important, since people who get emotionally wrapped up in the ups and downs of the stock market, often make mistakes that lead to less favorable results.

What are your views about rebalancing your portfolio?  I’d love to hear your comments. And if you have questions or would like to sit down and discuss your situation, please call me (1.604.833.0348) or send me an email (Lynn@LifestyleProtector.ca). I’ll be happy to talk with you.