2014 Semi-Annual Review: Portfolio Rebalancing Explained

In our annual review in January, we mentioned that despite some bumps in the road, 2013 had been a stellar year for equities overall. So far, 2014 has been most notable for its remarkable steadiness: by mid-June, U.S stocks as measured by the S&P 500 had gone 980 days without a 10 per cent decline—the fifth-longest such stretch on record.

This is good news for investors for obvious reasons—no dramatic plunges—but also because it gives them a lull during which to ponder how they should respond when the markets do finally become more volatile, as is bound to happen eventually.

If you’re skeptical that extra time to contemplate would result in useful scrutiny or an effective strategy, don’t worry: having entrusted your portfolio management to investment professionals, you’re already most of the way there.

Why? Because a volatile stock market is stressful, and research shows that people under stress tend to make emotional—not rational—decisions. Professional wealth advisors, on the other hand, can be trusted to make dispassionate decisions for their clients based on logic and metrics.

Understanding behavioural finance

New findings from a series of experiments conducted by Rutgers University psychologists show that when under moderate stress, people become more anxious about losses and less likely to notice small gains. As a result, they make investment bets that they associate with a higher probability of earning a smaller amount of money—and then, even if the gamble pays off, they don’t feel rewarded.

Put another way, stressed investors making emotional decisions tend to focus on their short-term losses and lose sight of how much they are likely to gain by staying the course, despite the established fact that actually, falling prices make assets more attractive to own.

Mauricio Delgado, the Rutgers neuroscientist who conducted the research, concluded that stress magnifies people’s inherent biases: conservative investors will become more conservative and risk-takers will seek higher levels of risk. Neither group will make the same rational choices they would have made when not feeling stressed.

If you were managing your own money, the current peace in the markets would be an excellent time to make decisions (perhaps even promises to yourself) about what you will do to weather stressful times ahead. As professional wealth advisors who follow a disciplined rebalancing methodology, we think now is an excellent time to explain how we plan to weather-proof your portfolio, and why it’s necessary. Our key recommendation is to rebalance your portfolio. Here’s why.

Avoiding asset drift

We know that historically, asset class returns tend to average out over time. In other words, the best-performing investments in recent times are unlikely to outperform over the coming period, and vice versa.

When equities have been rising steadily in value, your portfolio will gradually become overweight in equities compared to your desired asset allocation. That asset allocation was arrived at based on careful decisions about your risk tolerance, investment objectives and time horizon, so it’s essential to restore it. To do so, we sell equities and buy more fixed income.  Conversely, after a period of declining equities, client portfolios become overweight in fixed income. To rebalance, we sell fixed income and buy more equity. This strategy forces clients to systematically and unemotionally buy low and sell high.

Our disciplined rebalancing strategy eliminates behavioural biases and ensures clients’ portfolios are always rebalanced back to target.  As a result, if a major market decline were to occur, you would not be overexposed to equities; any short-term losses you incurred would be in line with expectations. Similarly, when the markets rebound, you will not be under-exposed to equities—so you will participate fully in the recovery.

This disciplined rebalancing methodology should lead to better investment returns in the long run.

Major Asset Class Returns to June 30, 2014

  6 Months 1 Year 3 Years 5 Years 10 Years






Global Bonds (CAD Hedged)






Canadian Stocks






U.S. Stocks






Int’l Stocks






Global REITs







1)     DataSource Dimensional fund Advisors

2)     Asset Classes: Cash—Canadian One-Month T-Bills; Global Bonds—Citigroup World Bond Index (hedged to CAD); Canadian Stocks—S&M/TSX Composite Index; U.S. Stocks—S&P 500; International Stocks—MSCI EAFE plus Emerging Markets (net div.); Global REITs—S&P Global REIT Index (net div.)

3)     Returns longer than one year are annualized.

4)     Returns expressed in CAD

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