Life’s about balance

Life’s about balance

about 5 years ago1 min

👍 As a general rule of thumb, a balanced portfolio contains a mix of investments (thanks in large part to modern portfolio theory). A very common setup is 60% stocks and 40% bonds, for example.

But investors who set investments up like this and then don’t keep tabs on them forget something very important: rebalancing ⚖️

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What’s going on?

Let’s take an investor who has a typical 60/40 portfolio: if stocks rise 10% in the next year while bonds fall 1%, the investor will be left with 62.6% of stocks and 37.4% of bonds – i.e. not the original split. In just a few years, a portfolio can easily drift significantly from its original setup.

That’s where rebalancing comes in: selling the extra 2.6% of stocks and buying an equivalent value of bonds would restore the desired 60/40 allocation.

Large investment managers regularly rebalance – so much so that analysts actually publish expected market flows from predictable rebalancing transactions 🔮

Why should I care?

Analysis by East West Investment Management shows that rebalancing works: in a dummy global portfolio of 50% stocks, 40% bonds, and 10% commodities, East West found that regularly resetting a portfolio’s weighting led to better investment returns than buying and holding.

All rebalancing improved investment returns (green arrow)
All rebalancing improved investment returns (green arrow)

And what’s more: rebalancing also lowered volatility – a proxy for risk (yellow arrow), meaning the higher returns weren’t (as they often are) thanks to taking on more risk.

East West also suggests that rebalancing quarterly might be best. Its dummy portfolio of Canadian stocks and bonds split 60/40 performed best when it was rebalanced quarterly – still, any rebalancing is better than none at all 🤓

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Disclaimer: These articles are provided for information purposes only. Occasionally, an opinion about whether to buy or sell a specific investment may be provided. The content is not intended to be a personal recommendation to buy or sell any financial instrument or product, or to adopt any investment strategy as it is not provided based on an assessment of your investing knowledge and experience, your financial situation or your investment objectives. The value of your investments, and the income derived from them, may go down as well as up. You may not get back all the money that you invest. The investments referred to in this article may not be suitable for all investors, and if in doubt, an investor should seek advice from a qualified investment advisor.

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