Why Rebalancing Matters
Over time, different asset classes grow at different rates, causing your portfolio to drift from its target allocation. Without rebalancing, a 60/40 portfolio can become 75/25 after a strong equity run — exposing you to more risk than intended. Rebalancing forces the discipline of selling high (trimming winners) and buying low (adding to laggards) — the opposite of what emotional investors naturally do.
Rebalancing Methods
| Method | Trigger | Pros | Cons |
|---|---|---|---|
| Calendar (annual) | Fixed date each year | Simple, disciplined, low maintenance | May miss large drifts between dates |
| Threshold (5%) | Any allocation drifts 5%+ from target | Responds to market moves, captures drift | Requires monitoring, may trigger frequently |
| Cash flow | New contributions directed to underweight assets | No selling required, tax-efficient | Only works during accumulation phase |
| Hybrid | Annual check + threshold override | Best of both approaches | Slightly more complex |
Tax-Efficient Rebalancing
In non-registered accounts, selling appreciated assets to rebalance triggers capital gains tax. Tax-efficient rebalancing strategies include:
- Rebalance in registered accounts first: Sell and buy within RRSP and TFSA where there are no tax consequences
- Direct new contributions: Put new money into underweight asset classes rather than selling overweight positions
- Use dividends and distributions: Redirect income payments to underweight assets instead of reinvesting in the same fund
- Tax-loss harvesting: If an asset class is both overweight AND has unrealized losses, selling achieves rebalancing while creating a tax deduction
How Often Should You Rebalance?
Research suggests that annual rebalancing captures most of the benefit with minimal transaction costs and tax impact. More frequent rebalancing (monthly or quarterly) adds negligible improvement while increasing costs. Less frequent rebalancing (every 2-3 years) allows excessive drift that can significantly alter your risk profile.
The optimal approach for most Canadian professionals: check allocations annually (perhaps at tax time), rebalance if any asset class has drifted more than 5% from target, and use new contributions throughout the year to keep allocations roughly on track. This hybrid approach minimizes both drift risk and transaction costs.