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Market and personal changes can trigger a need to rebalance the types and weights of assets in an investment portfolio.Getty Images

There’s no such thing as a set-it-and-forget-it portfolio for investors in exchange-traded funds (ETFs). The job is never really done. Market developments and evolving personal circumstances can call for periodic rebalancing.

“As investments change in value, the asset mix may drift away from the original mix,” says Alex Nayyar, vice president and portfolio manager with Treegrove Investment Management Inc., in Toronto.

An investor, he adds, might decide to put 60 per cent of a portfolio in stocks, 30 per cent in bonds and 10 per cent in cash. That allocation fits with the risk the investor is willing to take to achieve objectives. But over time, the performance of different asset classes will vary, causing values in a portfolio to shift, and altering the risk-and-return characteristics.

“This creates a need to rebalance the portfolio by selling some investments and buying others to bring the portfolio back to its original asset mix, which is based on the investor’s risk tolerance,” says Mr. Nayyar.

ETFs are a reflection of their holdings. “Their big appeal is that they hold a large number of underlying stocks or bonds. That significantly reduces the single-issue risk associated with a concentrated or individual stock position,” says David Kletz, lead portfolio manager at Forstrong Global Asset Management Inc., in Toronto.

Many factors affect the performance of the underlying assets in an ETF, including market risk, economic risk (interest rates, inflation, exchange rates), political risk, and other risks associated with the specific index, sector, commodity or geographic area that the ETF tracks.

“So rebalancing helps keep investors aligned with their target asset mix and investment strategy,” Mr. Kletz says.

Beyond making changes due to market conditions, he says investors may decide to take a fresh look at their portfolio makeup for several other reasons. Their investment views or risk profile might transform based on what’s happening in the world. Or their financial positions might change drastically due to a large inheritance, a health emergency, or the demand to finance a house or another major purchase. “There are definitely things that can happen that can trigger rebalancing,” Mr. Kletz adds.

Before rebalancing, investors can monitor the performance of their holdings through their accounts, an online portfolio builder or a financial website that tracks public securities. Mr. Kletz says it’s good practice to also monitor benchmarks that are relevant to risk tolerance or the universe someone is invested in, and then compare that with the ETFs in a portfolio.

Among rebalancing strategies, the two most common are calendar rebalancing and percentage of portfolio rebalancing, says David MacNicol, president and portfolio manager with MacNicol & Associates Asset Management Inc., in Toronto.

Calendar rebalancing is the simplest form, which involves bringing a portfolio to the target asset allocation at different time intervals, such as monthly, quarterly or annually. The biggest driver of this method would be portfolio drift, says Mr. MacNicol – how far you’re comfortable with the asset allocation of a portfolio drifting from its initial target.

Percentage of portfolio rebalancing is a more intensive approach. It involves rebalancing once an asset or asset class in a portfolio reaches a certain percentage threshold.

Rebalancing can open new opportunities in the ETF space, Mr. Kletz says. An investor might have been underweight in a certain segment of the market, and may decide to increase exposure to it, or invest in ETFs targeting a segment that’s currently in favour.

By rebalancing routinely, he says investors also “remove some of the emotion and judgment errors from decision-making.” Trimming some positions and buying additional units of others can bring investors back to their focused strategy. “That’s a good practice that effectively makes the process systematic.”

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