Managing Your Investment Risk
June 13, 2021
Rebalancing your portfolio is an effective strategy, writes Peter Watson.
The downside of investing is the underlying risk.
We can all agree that strong returns are acceptable and welcomed. At the same time, losing money is difficult to tolerate.
There is a well-known strategy that can assist. Rebalancing your portfolio.
We will assume you have a well-diversified and balanced portfolio. Owning just a few stocks presents different risks that are not covered in this article.
Start by determining your expected rate of return and the level of risk you are willing to accept.
This is done by deciding your asset allocation. What percent of your portfolio should be invested in stocks and what part invested in bonds.
The expected return on stocks is higher than bonds but the volatility, uncertainty, and the potential for loss is greater.
We will assume an investor will invest in what is often referred to as a 60/40. Stocks 60 per cent and bonds 40 per cent.
Over time, these two asset classes will likely perform differently. Assume the stock market posted significant gains which shifted the asset allocation from 60/40 to 80/20.
Now, the investor is too heavily weighted in stocks that is outside their targeted level of risk and asset allocation. The solution is to rebalance.
Rebalance to 60/40 by selling some stocks and buying some bonds.
The opposite is true. If stocks decline in value to say 40/60 then to rebalance you would sell bonds and purchase more stocks to reconstitute you to your targeted asset allocation which again, is your targeted risk tolerance.
Rebalancing can be to your advantage during a declining market. After stock values have declined, you sell some bonds to buy more stocks.
The stocks you purchase are trading at a discount to their previous value. When stock values appreciate you again will rebalance by selling stocks and buying bonds.
Rebalancing your portfolio is a good way to continually manage your investment risk.
Peter Watson is registered with Aligned Capital Partners Inc. (ACPI) to provide investment advice. Investment products are provided by ACPI. ACPI is a member of the Investment Industry Regulatory Organization of Canada. The opinions expressed are those of the author and not necessarily those of ACPI. Peter Watson provides wealth management services through Watson Investments.