How Often Should You Rebalance Your Portfolio?

It is often suggested that you should rebalance your portfolio every year. But you might ask yourself, "why every year"?

I think it makes sense to think about why you rebalance and what is happening to your portfolio when you do or do not rebalance. I believe that the top 2 reasons for rebalancing are:

• Control the risk profile of your portfolio
• Capture reasonable gains when they occur (buy low, and/or sell high)
  

How does rebalancing on a timed schedule (quarterly, yearly, etc) help with either of these goals? For example in a volatile market, with wild swings up and down in short time frames, we optimally want to rebalance frequently at market tops and bottoms. This would achieve both goals. In a stagnant market, we might not need to rebalance for many years. This would also achieve both goals.

However, if we agree that we cannot time the market, then we have no way of knowing where those tops and bottoms are, so most of us need some rules of thumb so that we don't forget to rebalance altogether (or rebalance too often--think about transaction costs and taxes on capital gains).

The rule of thumb that is easiest to remember is a timed schedule. This is also probably why it is the most frequently suggested rebalancing strategy. Maybe it's on your birthday, or after you receive your notice of assessment from the CRA. If you will forget to rebalance without a timed schedule, it makes sense to use calendar dates for rebalancing, whether you decide it is every quarter, every year, every 2 years, or whatever is convenient for you. The once-a-year suggestion appears to be historically sound and also keeps transaction costs within reason.

If you have more discipline and follow your portfolio more closely, a more direct approach to achieving the goals of rebalancing is to set limits on how much an asset is allowed to deviate from your target allocation. For instance if you have a 60/40 portfolio and you decide that a 10% deviation is when you are out of your comfort zone, you would rebalance if your portfolio became 70/30 or 50/50. The number you choose as your deviation limit depends on your risk tolerance and what you think are fair gains to cash out on. Using this method, you would be rebalancing whenever it is necessary according to your rules for achieving the rebalancing goals.

While I think that the timed schedule is a fine rebalancing strategy, it does seem to me to be an indirect way to achieving the ultimate goals of rebalancing. If you have the discipline and energy, setting deviation limits is probably a more direct approach.

iShares Sold to CVC

Barclays has sold iShares, the biggest ETF family in Canada, to CVC Capital Capital Partners Group. As Larry MacDonald writes, the chances of MERs increasing are probably higher for the Canadian iShares ETFs than in the US, where there is lots of competition.

Here in Canada, although we have ETFs from Claymore and Horizons, only iShares is offering market-cap weighted index ETFs. While I was previously not that excited by the upcoming BMO ETF offerings, maybe having some competition in the market-cap weighted index ETF space will be a good thing for investors.

Fund Fees for Currency Hedging

The performance of currency-hedged funds vs their non-hedged counterparts are largely based on currency fluctuations. Take a look at the yearly performance of the hedged and non-hedged TD e-Series funds. Everyone has an opinion on whether hedging is a good idea, and it seems to me that much of it has to do with recency.

In any case, I thought it would be interesting to see how much fund companies are charging for the benefits (whatever the benefits may be) of currency hedging:

Index/Sector	Hedged Fund	MER	Details	Hedging Fee
iShares
S&P 500	XSP	0.24%	Holds IVV (0.09%)	0.15%
Russel 2000	XSU	0.35%	Holds IWM (0.20%)	0.15%
EAFE	XIN	0.49%	Holds EFA (0.34%)	0.15%
Claymore
Core US	CLU	0.65%	Non-hedged CLU.C charges 0.65%	0.00%
Emerging Markets	CWO	0.65%	Holds VWO (0.27%). Since VWO is not a Claymore fund, the CWO MER is on top of what is charged by VWO.	0.65%
Global Dividend	CYH	0.65%	Holds 60/40 split of HGI (0.65%) and CVY (0.60%). Blended MER is 0.63%	0.02%
TD e-Series
US Index		0.48%	Non-hedged MER 0.33%	0.15%
International Index (EAFE)		0.50%	Non-hedged MER 0.48%	0.02%

Those are the currency-hedged funds I was able to find from iShares, Claymore, and the TD e-Series funds. I also wanted to look at the BMO ETFs, but will wait until they are actually trading before running through this exercise with them.

I'll let you decide whether or not currency hedging is a good idea, but you can see that funds are charging quite a wide range of fees for the service. iShares seems to charge a "standard" 0.15% which in my opinion is a little high. Then there is Claymore, with a wide range of fees depending on the fund, from 0.65% to hedge world currencies (CWO), down to 0% for US Dollars (CLU vs CLU.C). One point to note is that if you are interested in a hedged version of the EAFE index, it may be more cost effective to use the TD e-Series fund at 0.5% MER versus XIN which charges 0.49% MER since the TD e-Series funds don't incur transaction fees.

Consider All Sources of Income When Forming a Portfolio

When you think about your portfolio, take into consideration more than just the assets sitting in your brokerage or mutual fund account. For instance if both you and your spouse work in the high tech industry, maybe you don't need to have so many high tech stocks. Or if you work in real estate and have a couple of investment properties, it might not make sense to invest in REITs since a real estate crash would affect your job, as well as your investments.

Similarly, although you may really like your employer, holding substantial assets in company stock is dangerous. The classic example of this is the Enron case, where employees not only lost their jobs, but many also lost their retirement savings. Either one of these would be terrible on its own. Having both happen is devastating.

Consider your entire financial situation when creating your portfolio so you won't have any unexpected surprises.

Chou Funds Returns Management Fees

Rob Carrick reports that the Chou Europe Fund will refund its management fees. The fund has not performed to Mr. Chou's satisfaction and it's an amazing show of character that he is refunding fees that he feels he has not earned. Although it would be nice if this were the norm, I would guess that other fund managers aren't going to follow suit.

Investorline Accounts Have a CAD Side and a USD Side

If you deal with BMO Investorline, it's good to know that your account has a Canadian dollar side, and a US dollar side.

If you purchase a US-listed security and settle it in Canadian dollars, your purchase will sit in the "Canadian side" of your account. Any distributions from that security will be forexed (with a charge to you) to CAD.

If you had purchased that security and settled it in USD, then the holding will sit in the "US side" of your account and distributions will be received in USD.

For example, if you purchased 100 units of US-listed stock ABC with US dollars, and then 200 units more with Canadian dollars, your account with show two separate lines for stock ABC. One line will show 100 units, and the other will show 200 units. If you receive some distributions from ABC, the amount coming from the 100 units will be received in US dollars, while the amount from your other 200 units will be automatically exchanged into Canadian dollars. You can bet that the brokerage is taking a bit of cash for the foreign exchange "service".

If you're in this position, you can simply make a call to Investorline support and ask them to move all the units to your US side. The next day, you'll see one line in your account (in the case of the example above, you'd see one line showing 300 units of ABC). All your future distributions from that stock should be received in US dollars.

Tax Refunds Cost You Money

Around this time of year, most people look forward to a nice big tax refund cheque from the CRA. The average refund for 2007 was $1440, a pretty substantial amount. Plenty of people (including financial advisors) will suggest treating yourself to something nice. $1440 will buy you a pretty nice TV, for example. But let's think about where that money came from first.

The government is not giving you free money. It's actually returning your money. Money that you overpaid through the year. In fact, because you overpaid, you've given the government a free loan and you didn't even get to earn any interest on it. So getting a big refund is actually to the government's advantage, because they certainly are getting a better-than-zero return on the cash you've graciously lent them.

One argument in defense of tax refunds is that they are like a forced savings, taking money out of your hands that you might otherwise have spent. Well, if you need to be on a forced savings plan, why not set one up yourself that sends regular deposits from your chequing account over to a high interest savings account or a money market fund. At least that way the money is working for YOU, and is way more liquid (should you really need it) than waiting for a cheque once a year.

It's probably to your advantage to actually owe a little bit on your tax return. However, you will need to budget for the amount owing at tax time. In the end, though, the fairest result would be to have no refund and no amount owing.

If you find yourself regularly getting a large refund, you can fill out form T1213 to request to have tax deductions reduced.

So if you get a refund this year, before you go and spend it, remember that it's not free money, and it's not a bonus. It's cash that you should have had in your hands already. Cash that you should have been able to put to work for yourself. Use the money like it was already yours, except that it was put away in an account earning you 0% and locked up until a few weeks after you file your return.