Portfolio rebalancing: How to manage your investments for long-term success

The past year was a standout for financial markets. Stock markets surged, retail trading boomed, and optimism seemed to drive investment decisions.
Whether you’re a new or experienced DIY investor, it’s easy to get swept up in the excitement of a bull market run and lose sight of your long-term investing strategy. Achieving your financial goals requires understanding yourself as an investor, knowing your risk tolerance, and ensuring your portfolio remains balanced and aligned with your time horizon.
Knowing how a balanced portfolio works, why portfolios drift and how to rebalance effectively is essential to meeting your financial goals.

What is portfolio rebalancing?
A balanced portfolio involves allocating investments across various asset classes, such as stocks, bonds, and cash, in ratios that align with your risk tolerance, time horizon, and investment strategy. For example, a younger investor may prioritize equities like stocks for growth potential, while older investors often favour fixed-income investments like bonds to reduce risk and preserve the earnings accumulated from investing.
Over time, market fluctuations, sector performance, global events, and trends can cause this mix —known as asset allocation — to drift away from the target asset mix and risk level that you started with. This phenomenon is called portfolio drift.

Portfolio rebalancing addresses this drift by restoring your original asset allocation. This involves buying or selling assets to bring your investment portfolio back to its target balance. Think of rebalancing as a routine check-up for your investments — similar to steering a car back on course after a slight deviation. By reviewing and adjusting your investments periodically, you ensure your portfolio stays on track with your risk tolerance and goals as you continue on your investing journey.

Why does portfolio drift occur?
Several factors contribute to portfolio drift:

• Market performance: As of 2024, the TSX has grown by 21.54 per cent. For Canadians with TSX-focused investment funds or stocks in their portfolios, this surge might mean the overall value of stocks in their holdings has risen significantly, while fixed-income assets may have declined.
  A portfolio favouring these TSX stocks could yield higher returns but exposes you to greater market volatility. Remember, this deviation from your original asset mix and risk level could leave you vulnerable to a bear market or a sudden drop in stock prices.
• Seasonal trends: Short-term events can also change your portfolio’s balance. The Santa Claus Rally, where stock prices often rise during the final week of December or the January Effect, where stocks, especially small-cap equities tend to perform well at the start of the year, could also impact your asset allocation.
  Political and economic events: Major political or economic changes can have a big impact. For example, the outcome of 2024 US election has caused the US stock markets to surge and interest in alternative investments like crypto to increase significantly. While these changes may offer growth opportunities, they also introduce risks tied to global trade, increased speculative trading, regulatory changes, and market uncertainty.

Why should you rebalance your investment
portfolio?
By routinely rebalancing, you ensure your portfolio is well-diversified, a cornerstone of sound investing. For those implementing a specific investment strategy, rebalancing can help maintain your strategy.

Monitoring your portfolio also becomes especially important during significant market swings. According to Vanguard’s 2020 study titled “The Value of Advice: Assessing the Role of Emotions,” investors with clear financial goals were more likely to stick to their strategies during turbulent times. The research showed that following a plan reinforced long-term thinking and helped investors avoid chasing short-term gains out of FOMO (fear of missing out).

How and when should you rebalance your portfolio?Timing when to rebalance is just as important as the process itself. Studies show that a planned approach to monitoring investments reduces the risk of over concentration in a single asset or sector. Here are three common approaches:

• Calendar rebalancing
  This approach involves reviewing your portfolio allocation at regular intervals such as quarterly, semi-annually, or annually. However, one critical aspect to remember is that rebalancing too frequently or infrequently can be inefficient. Rebalancing too often may result in higher transaction costs and larger tax implications, especially in taxable investment accounts. On the other hand, rebalancing too infrequently can cause your portfolio to drift too far from the target allocation over time.
• Threshold-based rebalancing
  This method, which is sometimes used by asset managers, allows your portfolio allocations to drift within a tolerance threshold. Rebalancing only occurs when the value in your portfolio exceeds this range. For example, if your target allocation within your portfolio for equities is 60 per cent, the threshold-based approach would require rebalancing if the equity allocation exceeds 65 per cent or falls below 55 per cent.
  One drawback of this method is that threshold rebalancing requires frequent monitoring, which may not be practical for some DIY investors.
• Hybrid rebalancing
  Hybrid combines the calendar-based and threshold-based approaches. Asset allocation weights are checked at regular calendar intervals, but changes are made only if your investments have drifted beyond your target percentages by a certain amount.

Successful investing isn’t about perfect timing or chasing market trends. It is about making informed, disciplined decisions that align with your unique financial journey. Your portfolio is more than just numbers — it’s a reflection of your goals and long-term vision. By staying proactive and periodically rebalancing, you can keep your investments on track for long-term success.

Rebecca Vargese
Communications Coordinator
Alberta Securities Commission
Suite 600, 250-5th Street SW, Calgary, AB, T2P 0R4
Phone: 403-297-4968
Cell: 403-542-9162
Fax: 403.297.6156
Email: Rebecca.Vargese@asc.ca