Periodically, individuals should take a look at their portfolios (with their advisor if needed) and examine whether the current asset allocation is reflective of their goals. Most advisors and individual investors start with an asset allocation of some kind, 30% bonds, 60% equities, 10% cash is a common equation for example. However, over time, if left alone this alignment will get out of proportion, as one investment class is likely to grow faster than the others.
At this point, you need to re-examine your investment goals and move towards rebalancing your portfolio to a level of risk that you are comfortable with. Here are some points to consider to reduce your transaction costs when rebalancing your portfolio:
Mind the Taxes
Selling investments in a non-registered account will attract taxes if you are realising a capital gain, so it is often best to sell stocks you own in an RRSP rather than in your non-registered account. The opposite is true if you are selling a stock that will provide a capital loss of course, and would rather do so in a non-registered account. Still, taxes represent the largest potential cost you may face when rebalancing your portfolio. If you are unclear on what taxes you may incur by selling certain securities, it is best to consult your advisor for help as this can make a real difference in your reconciliation with the tax man at the end of the year.
Take a look at your fees
When you rebalance your portfolio, examine the fees you are paying on any mutual funds or exchange traded funds (ETFs) that you are holding. If you are holding two or more funds of a similar class, it may be time to reduce that into one fund that has the lowest fees. Holding two TSX index funds does not provide diversification, only higher fees!
In general, this can be good time to switch into lower cost funds if you’ve been stuck with a higher cost fund from the past. In general, it doesn’t cost more to sell 100 units of a fund compared to 10 units of a fund, so if you are doing a transaction anyway to rebalance, this may be a good time to make a complete switch. Take advantage of the opportunity and use your commissions to realise the biggest returns for your portfolio.
Look into a DRIP
More on Investing
Once you’ve rebalanced your portfolio, take a look at any dividend paying stocks you have and consider enrolling in the DRIP (Dividend Reinvestment Plan) if there is one available for that stock. These plans will pay your dividends out as additional stock, rather than cash, and generally offer you a premium for doing so. This reduces your future transaction costs as well as you don’t have to pay a commission to reinvest your dividends, they are already reinvested!
While rebalancing a portfolio is clearly a good idea from a portfolio management perspective, one must be mindful of the costs of doing so. Minimizing taxes, optimizing the fees you pay and considering DRIPs for your dividend paying costs are all steps that you can take to reduce fees when dealing with rebalancing your portfolio.
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