The science behind portfolio re-balancing
Today’s investors have the benefit of advanced science coupled with leading-edge investment management practices to create portfolios that seek to automatically take advantage of the ups and downs of the market. That’s why investors who work with a professional advisor and invest according to a detailed plan don’t worry about trying to “Buy low and sell high”.
Avoid emotional investing
“Ask a room full of people how they react to a falling market and most will say it makes them upset, nervous, maybe even angry,” says veteran investment manager and Regional Director, IG Wealth Management, Andrew Mackenzie. He cautions investors to be wary of these emotional responses to market volatility. “Emotions cause most people to do the opposite of ‘buying low and selling high’. It’s our job, as advisors, to help our clients see the advantages of volatility at every life stage, instead of simply reacting to the constant ups and downs” he adds.
Put volatility to work for you
Markets are unpredictable. They go up and down all the time because the value of individual companies, sectors, and regions are constantly changing. “Knowing that volatility is the only thing we can predict with certainty actually creates a huge opportunity to put it to work for you,” says Mackenzie. “A potential answer is to use automatic portfolio rebalancing”.
Here’s how portfolio re-balancing works:
A typical investment portfolio is made up of three parts or asset classes.
- Equities (stocks or mutual funds) – these investments usually fluctuate the most.
- Fixed-income investments (GIC's and bonds) – these investments typically fluctuate less than equities.
- Cash and cash equivalents (money market funds) – virtually no fluctuation.
The balance of each asset class is based on the investor profile that you created with your IG Consultant. The portfolio below is a typical, balanced portfolio.
If the equity portion of this portfolio was to grow significantly faster than the fixed income and cash portions, the balance would get out of whack. It would more like this:
In order to restore the “balance”, the portfolio manager would sell equities and move the profit into the other two portions. In simple terms, “Sell High!” The opposite is also true.
If the equity portion of a portfolio falls in value, it means those investments are worth less than they were when the portfolio was last rebalanced. To restore balance, money gets moved from the fixed income and cash portions to buy equites when they are cheaper. In simple terms, “Buy low!”
This is how the process of automatic rebalancing overcomes the emotional biases that can affect an investor’s long-term potential to generate the highest possible returns.
“When investors see how rebalancing works, they are less inclined to feel anxious when markets dip,” says Mackenzie. “They now see both sides of volatility as an opportunity to buy low and sell high.”
Re-balancing throughout your life stages
Re-balancing plays a part in helping you reach your goals throughout your lifetime. During the ‘accumulation phase’ of life, you are trying to grow your assets. In the ‘distribution phase’, you are turning your assets into an income-generating machine that will pay for your retirement lifestyle.
|
Phase |
Accumulation |
Distribution |
|
Your focus |
Growing assets that can be used to generate income in retirement. |
Creating a steady, predictable income to pay for your lifestyle. |
|
How |
With time on your side, you benefit from a longer period of compounding growth potential. Re-balancing ensures that you continue to buy low and sell high throughout your asset-growing years. |
With a shorter time horizon, you want to avoid sudden dips in your portfolio that could take years to replenish. Re-balancing helps to stabilize your investment portfolio so that you can plan to withdraw a consistent amount every year. |
Published by IG Wealth Management as a general source of information only. Not intended as a solicitation to buy or sell specific investments, or to provide tax, legal or investment advice. Seek advice on your specific circumstances from an IG Wealth Management Consultant.