Is Your Portfolio Overweight?

After the cold weather lifts, we often turn our attention to physical health. After all, Canada's long winters can lend themselves to a few extra unwanted pounds! But what about financial health? What better time than the start of a new season to check in on that, too?

Just as carrying excess weight is a known health risk, an overweight investment portfolio presents its own risks. Thanks to a lengthy bull market in equities, it's been an exciting time — and a boon — for many investors. At the same time, as the equity portion of a portfolio grows in a bull-market environment, investors may find themselves overexposed in that part of their portfolio. That leads to increased risk when markets change course. What's the solution?

What is rebalancing and why should you care?

Portfolio rebalancing may not hold the excitement that investing itself does, but it's an important part of an investing strategy that keeps you engaged with your investments, organized and in control. While asset allocation is largely responsible for the risk-and-return characteristics of your portfolio, rebalancing ensures that your target allocation doesn't drift from your original plan. It's that drift that can expose you to more risk based on your time horizon and financial goals.

Common asset classes include equities, fixed income and cash. Depending on your goals, a possible mix in a portfolio that's considered balanced might have 60 per cent equities, 35 per cent bonds and 5 per cent cash or equivalents. Model portfolios, designed by investment professionals, allow you to see portfolio mixes designed for investor profiles ranging from very conservative to aggressive growth. Because different asset classes have different returns over time, the percentage, or weighting, in any one class can drift. So, for example, what began as a 60-35-5 allocation could become a 70-25-5 mix if equities are outperforming, meaning greater exposure to risk if markets shift.

Enter rebalancing. A key reason for rebalancing is to minimize asset-specific risk. Think of it like tending a rose garden: If you don't prune it, that bramble of beautiful blooms won't grow the way you want it to.

Sounds simple, but rebalancing — like pruning — can feel a bit counterintuitive. Why should we cut back when things are in full bloom? While rebalancing can mean making a decision to sell a successful investment (or a portion of it), it can free up money to buy an asset in another part of your portfolio to return you to your originally planned asset mix.

A look at best practices

There are no hard-and-fast rules about frequency or specific timing when it comes to monitoring and rebalancing a portfolio. Let's face it, sell decisions can be much harder than buy decisions. That's often due to investor biases like loss aversion. Some experts tout a portfolio review one or two times a year, while others suggest any time you're seeing a shift in markets. A common recommendation is to set a limit for how much drift you're comfortable with and consider rebalancing when you hit that level.

How do you check? The Portfolio Analyzer tool, found under My Portfolio, allows you to easily view your portfolio's mix of investments and monitor risk. The Performance page, also under My Portfolio, allows you to evaluate the rate of return on your portfolio.