Can You Tweak Your Way to Investing Success?

Gone are the days of the mega-makeover. Today, "tweakments" — anything from a 30-minute vitamin IV drip for fitness enthusiasts to infusion micro-needling for skin repair— are de rigueur for personal care. Small adjustments can be both less expensive and less time consuming than major overhauls, and they aim to correct minor issues before they become bigger problems. Could self-directed investors benefit from tweakments, too? Regular efforts to tweak, or rebalance, a portfolio could help keep it in "good health" and may even be time-, cost- and tax-efficient.

Asset Mixology 101

Many investors own a mix of asset classes, like equities, bonds, cash and real estate, because they tend to perform differently in various market cycles. How much an investor allocates to each is based on factors such as investment time horizon, risk tolerance, financial goals and income needs. For example, someone with a high risk tolerance and a long-term investment horizon might allocate more to equities, which have the highest potential return due to their higher risk level. Someone on the other side of the risk spectrum may choose to allocate more to lower-risk, lower-reward type investments, such as bonds. Asset mix is a key driver of performance in addition to the total return you get from your investments (capital gains plus income received).

Is Rebalancing for You?

Portfolios can gradually drift away from their original asset allocation, which may change its risk/return profile. Imagine a portfolio that starts with a 60/40 allocation to stocks and bonds. If stocks outperform bonds, it might tilt toward 70 per cent equities and 30 per cent bonds, or even more, exposing the portfolio to greater equity risk.

Rebalancing can be difficult for some investors for various reasons, particularly when emotions factor in. During a bull market, for instance, investors may be loath to give up the prospect of future equity gains. Or an aversion to loss may cause reluctance to sell an underperforming investment.

If you're looking at a rebalance, some investors choose to start with the broad asset classes — equities, fixed income (bonds or GICs, for example), cash — and tweak from there. Here are three straightforward ways to go about a rebalance.

1. Time Tweaks

This is probably the easiest and least emotionally challenging way to rebalance asset allocation. Simply choose a date — for example, near the end of the calendar year as part of tax planning. When that time comes, ask yourself: Where is my portfolio now? If it's drifted too far from your original allocation, then it may be time to consider selling investments that have become overweight in your portfolio and buying investments in asset classes you want to increase.

2. Threshold Tweaks

This method is based on how far your asset mix has diverged from your original plan. First, decide on your threshold tolerance. For example, if you set your threshold to a 10 per cent divergence in either direction, then only when an asset class moves more than 10 per cent away from the original weighting would you tweak. Let's assume you have a 60/40 equity/bond portfolio. A 10 per cent band means the acceptable range can go as far as 70/30 or 50/50 before you step in. (Note that this tweaking style requires regular portfolio monitoring.)

3. Combo Plan

Another option is to review your portfolio on a calendar basis, say annual or semi-annual, but tweak only if it is out of the bounds of the threshold.

What's the right amount of "tweaking"? There's no right answer, but it's important to keep a couple of things in mind. Depending on your portfolio mix, too little (or no rebalancing at all) could leave you taking on more risk than you intended, while too many tweaks might contribute to increased costs for trading commissions, thereby lowering your overall returns.