A step-by-step guide to rebalancing your ETF portfolio.
“Rebalancing an ETF portfolio” refers to the process of adjusting the weights of different assets within a portfolio back to their target allocations.
Over time, due to market fluctuations, the actual percentage of each asset class (such as stocks, bonds, or specific sectors) within a portfolio can drift away from the investor’s intended asset allocation strategy.
Rebalancing ensures that the portfolio remains aligned with the investor’s risk tolerance and investment objectives by periodically buying or selling assets to match the original or updated target allocations.
1. Risk Management: Without rebalancing, an investor’s portfolio may become riskier or more conservative than intended. For example, if stock ETFs have performed well, they might constitute a larger portion of the portfolio than initially planned, exposing the investor to greater risk in case of a market downturn.
2. Maintaining Investment Strategy: Rebalancing keeps the investment strategy on track, ensuring that the portfolio’s allocation continues to reflect the investor’s goals and time horizon.
3. Opportunity for Review: The rebalancing process provides a regular opportunity to review in investor’s portfolio performance, evaluate the effectiveness of the chosen strategy, and make any adjustments that may be necessary, if the investor’s life situation has changed since the last review.
1. Determine Your Target Allocation: The first step in building an ETF portfolio is to have a clear understanding of the desired percentage of each asset class or specific ETFs in the portfolio. For example, my allocation, at one point in time recently was, 45% U.S. stocks, 30% Canadian Stocks, 15% International Developed Markets stocks, 2% Emerging Markets stocks and 3% Bonds.
2. Assess Your Current Allocation: Evaluate the current percentage of each asset class or ETF within the portfolio to identify deviations from the target allocation. In my recent example, my US stocks had grown to 47%, Canada had dropped to 28%, while my international and bond allocation had remained on target. So to rebalance, I needed to add more Canadian stocks to balance my portfolio.
3. Buy (or Sell*) Assets: To realign the portfolio with the target allocation, buy more of the underweight assets or potentially sell some of the overweighted assets. Since many low-fee brokerages like Questrade offer free ETF purchases (but charge a fee to sell ETFs) it can be advantageous to hold overweight ETFs (*i.e. don’t sell any), and to add to underweight ETFs. In my example, I used my available cash to buy more shares of my Canadian equities ETF, bringing my portfolio back into balance.
4. Timing and Frequency: Decide on a rebalancing schedule—this could be on a regular time interval (such as quarterly, semi-annually, or annually) or based on deviation thresholds (e.g., rebalancing whenever an asset class shifts more than a certain percentage from its target allocation). There is no right or wrong approach to timing and frequency, so do what you feel is most convenient for you.
It’s important to note that rebalancing can incur transaction costs and there could be potential tax implications, especially if done frequently or in a taxable account. So, it’s important to consider a few different things when establishing a rebalancing strategy.
Many investors choose to rebalance their portfolios in a tax-advantaged account (such as a TFSA, RRSP or FHSA in Canada or an IRA or 401(k) in the U.S.) to minimize any capital gains that may come from selling ETFs.
Additionally, if you still use a big bank trading platform that charges fees for all buying and selling of stocks or ETFs, rebalancing frequently may incur higher trading costs. One benefit of using a low-fee brokerage, like Questrade, is that they don’t charge a fee for ETF purchases, so it makes balancing easier and cheaper.
If you’re into spreadsheets, I’ve created a (free!) ETF portfolio Rebalancing Template in Google Sheets. Feel free to make a copy and use this template to hlep you balance your own portfolio.
If you want to automate the reblancing process as much as possible, and you use Questrade as your brokerage, you can set up a free Passiv Elite account (currently free for Questrade users!) and it will do things like: notify you when your portfolio is out of balance, tell you how many shares of each ETF you need to buy, allow you to perform one-click buys, and even send dividend payment notifications when you receive dividends or distributions from your stocks and ETFs.
I use Passiv all the time, and love it. Check out my full Passiv review for more details.
