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Q I have been investing with the Couch Potato method for several years now and I really like it because it is such a simple strategy. Still, I’m very sloppy when it comes to rebalancing. It’s been six years since I balanced my RRSP and TFSA, but my returns are still very good. What returns can I expect in the future if I never rebalance my asset allocation? Would it make that much of a difference to profits over a 30-year period? I would really like to avoid having to rebalance if possible. What do you suggest?
-Incision
AND. The name of the couch strategy itself suggests that it is based on laziness and neglect. And there is some truth to this: tinkering with a well-diversified portfolio will likely sabotage your returns rather than improve them. Changing your asset allocation based on market forecasts can also backfire. So it’s best to just design your portfolio thoughtfully and then largely leave it alone.
But you can take this idea too far. And deciding never to rebalance definitely crosses that line.
Nick, you mentioned that you haven’t rebalanced your portfolio in six years, and yet the returns are “still very good.” Without a doubt. In fact, if you have a global portfolio of stocks and bonds, your returns almost certainly were better than if you rebalanced every year.
Over the past six years (ended June 30), Canadian bonds have returned approximately 4.1% annually. Meanwhile, Canadian and international stocks returned around 8% to 9%, while the United States eclipsed them all with annual growth of more than 16%. So over this period, rebalancing would mainly involve selling stocks that have performed well recently and then buying bonds that have continued to deliver more modest returns. By keeping your portfolio unchanged, you would outperform an investor who carefully rebalanced his assets about once a year.
But as I explained in a recent column, the goal of rebalancing is not to improve profits. Its main goal is risk control. When you started your portfolio six years ago, you probably decided on the appropriate asset allocation. Let’s assume it was the classic mix of 40% bonds, 20% Canadian stocks, 20% US stocks and 20% international stocks. Because the returns of these four asset classes varied significantly, your mix would now be much different: your bond allocation would drop to about 30%, while U.S. equities would likely rise to about 30%.
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It’s a very different portfolio than the one you designed six years ago: with less fixed income, it’s generally riskier. If you continued this trend for 30 years, the problem would likely get worse and your portfolio would become more and more aggressive.
We haven’t experienced a significant bear market over the last half-dozen years, but we will at some point. And if you have a much larger allocation to stocks by then, your losses in the next downturn will be greater than you expected.
The good news is that Couch Potato investors who avoid spreadsheets have better options than in the past. The three largest ETF providers in Canada: Van, iShares AND BMO— have all recently launched families of “asset allocation ETFs” that do all the work for you. Each of them has a globally diversified portfolio of stocks and bonds with a target set of assets: from conservative portfolios containing only 20% of stocks to aggressive portfolios of 80% of stocks. The fund manager will maintain the portfolio to keep it very close to its long-term goals, so investors get the best of both worlds: risk management that ensures regular rebalancing, and the convenience of not having to make their own trades (except adding new money).
Nick, I suggest you consider using one of these single ETF portfolios. Simply choose the one that best suits your risk profile, then liquidate your existing investments and replace them with this simple solution. Since you are investing in a TFSA and RRSP, there will be no tax consequences and the small number of trading commissions will pay off in the long run. You can probably complete this transformation in about 30 minutes, and then you can safely go back to ignoring your portfolio and letting the markets do all the work.
Dan Bortolotti, CFP, CIM, is a portfolio manager and financial planner at PWL Capital in Toronto.
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