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Time to rebalance?
Equities continued to surge during April into early May when the S&P 500 and Dow Jones Industrial Averages both hit record highs. US stocks have now had five straight years of steady upwards gains. As a result, seasoned investors are taking a fresh look at their portfolios to see whether some rebalancing is in order.
Maintaining an effective balance between fixed income and equity investments is crucial to ensuring better longer-term and steadier returns. In general, a typical portfolio consists of weightings of roughly half stocks and half bonds, though this will vary with your age.
The younger you are the more stocks (which tend to earn more over time) you will want to hold and the closer you get to retirement the more bonds (which provide greater security) you will want. Regular rebalancing works because it acts as an “automatic stabilizer,” forcing you to buy stocks when they are cheap (as they were following the 2008-2009 financial crisis and ensuing recession) and pushing you to sell, when they are expensive.
For example if five years ago (at the start of 2009) you had held a portfolio of half Canadian stocks and half bonds and still do so today, after the S&P TSX has more than doubled in value (gaining far more than bonds did during that time) you would now likely want increase the bond portion of your holdings.
Right now with Canadian 10 and 30 year Treasuries paying out just 2.35% and 2.94% (as at April 30th) it’s hard to convince anyone that bonds are a good deal. However retaining a bond allocation remains crucial for several reasons.
Bonds are an excellent deflation risk. They are far safer than stocks, a crucial attribute in the current high volatility environment. And finally, if you ask investors in Japan, where rates have remained low for well over a decade, those returns, small though they may be, could turn out to be just fine. Furthermore, bonds as a category including corporate issues, have also done well since the start of the year. For example the DEX Universe Bond Index rose 3.72%.
How to rebalance?
The good news is that if you hold a balanced mutual fund, the most popular category, you really don’t have to worry much. Balanced funds automatically adjust towards their benchmark targets, within a very narrow band, on a monthly basis. All you really need to do from time-to-time is to make sure that the target allocations of the fund that you are invested in reflect your needs for this particular point in your life.
However those who own a range of funds need to tally their respective holdings from time to time, to make sure they have the right amount invested in both fixed income and equity investments.
If the amounts get out of whack, for those who have a disciplined approach towards investing, and are making steady annual contributions in their retirement funds, the best way to rebalance is to make future purchases in the category in which they are underweight. This avoids the possible tax consequences of selling an unsheltered fund and rebalancing into another.
The bottom line is that if you are like many Canadians, the value of your equity investments has risen substantially in recent years. But now is not the time to pat yourself on the back. Now is the time to review your benchmark allocations to make sure they reflect your long-term needs.
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