Is it time to rebalance your client’s portfolio?
Like dental cleanings and oil changes, portfolio rebalancing is an oft-neglected chore for many Canadian investors. Here’s why it might be time for a course correction
Date: December 15, 2016
The list of chores that people tend to put off is a long one: dental cleaning, oil changes for the car, tackling the mounting clutter in the basement or garage. Investors, too, have their own oft-neglected chores, whether they know it or not.
Put portfolio rebalancing at the top of the “to do” list for many Canadians. No matter how precisely investors and their advisors determine the correct risk profile and balance between equities and fixed income, the optimal mix is bound to get out of whack over time and addressing the issue is not as automatic as it should be.
“Your car’s light will come on when you need an oil change, but balancing a portfolio may not be as obvious to people,” says Cindy Crean, managing director, private client, with Sun Life Global Investments.
Perhaps the biggest benefit of portfolio rebalancing, an exercise that Ms. Crean says should happen annually, is that it limits investors’ propensity to hold onto their winners too long.
She provides the example of an investor looking over a portfolio after a “huge run-up” in equities, which may have swung a portfolio’s balance from a targeted 60-40, equity-fixed income balance to 65 per cent equities. “It is a good time to rebalance, because what you are actually doing is selling high and you will recognize some of that gain.”
Rather than a dreary chore, rebalancing should be positioned as a way of maximizing the performance of a portfolio – putting more money into what has underperformed by selling more of what has risen the most. (Otherwise known as selling high and buying low.)
The business media is full of tales of formerly high-flying stocks that eventually came back to earth while investors stubbornly held on – RIM/Blackberry and Nortel being two of the most notorious Canadian examples.
“You get a bit of an emotional attachment and can hold on too long. Rebalancing can remove some of the emotion,” says Ms. Crean. “Generally, by having that kind of discipline [of rebalancing] over time, it is going to hold you in good stead and probably conserve capital a lot more.”
Financial advisors may also have to overcome clients’ psychological aversion to rebalancing – a reluctance people may have to selling their “winners,” says Sandra Foster, author and president of Headspring Consulting Inc.
“Some people don’t like to rebalance because they like to see the profits that they have earned in their portfolio,” says Ms. Foster, author of You Can't Take it With You: Common-Sense Guide to Estate Planning.
Rebalancing might not be as satisfying as looking at those big (often fleeting) gains in a portfolio, but it serves to de-risk investment holdings to a certain degree, adds Ms. Foster.
“If equities have done really well and you now have a higher percentage of equities than your strategy originally called for, that would mean you have more risk in your portfolio and are more exposed to risk in the marketplace than you had originally bought into,” she says. “Rebalancing allows you to reset the level of risk back to your original target.”
If rebalancing means selling off high-flying stocks, it can also have tax implications if part of the portfolio is outside of registered plans such as an RRSP and TFSA, adds Ms. Foster. Advisors can play a role in anticipating, or even minimizing, this potential issue.
Investors might also want to automate the chore of rebalancing their holdings through a managed portfolio which can carry out the practice automatically.
“With a managed portfolio, [the client] knows the portfolio manager is actually doing that tweaking and rebalancing for [them],” explains Sun Life’s Ms. Crean. “That portfolio manager could be taking advantage of things that are happening in the marketplace and being more active than an average retail investor.”
One investment largely overlooked when the subject of rebalancing comes up is cash, notes Ms. Crean. Cash that is held in large bank balances or in a money market account may act as a drag on overall returns.
“Some people squirrel away some cash and think, ‘This is my safety,’ but cash is not making really big returns and you are paying tax on that interest; this combined with inflation can result in actually losing money with cash,” she says.
There can be a generational component to cash hoarding as well. A 2016 investor survey by Sun Life Global Investments showing that millennials (the children of the baby boomers, aged around 18-35) are holding more cash than they should because they are fearful of market volatility, despite having a long investment horizon.
“It is a huge opportunity cost [to have the money] just sitting there,” says Ms. Crean. “That is why it is important [for clients to] sit with an advisor and ask, ‘What is the risk of holding this cash, as opposed to getting it into a well-balanced portfolio?’”
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