The Canadian Investor's Guide to Portfolio Rebalancing (2025)

1. What is Portfolio Rebalancing?

Portfolio rebalancing is the process of periodically buying or selling assets in your investment portfolio to maintain your original or desired asset allocation. As Wealthsimple puts it, "Portfolio rebalancing is moving your money between investments so you can maintain the perfect balance to help you achieve your financial goals."

Over time, the different investments in your portfolio will grow at different rates. For example, stocks might outperform bonds, or one sector might surge while another lags. This uneven growth can cause your portfolio's actual asset mix to "drift" away from your target asset allocation – the specific blend of asset classes (e.g., 60% stocks, 40% bonds) you initially chose based on your financial goals, risk tolerance, and time horizon. Rebalancing brings your portfolio back in line with these targets.

For investors across Canada, from coast to coast, rebalancing is a key discipline for long-term success.

2. Why is Portfolio Rebalancing Important?

Rebalancing your investment portfolio is a crucial discipline for several reasons, as highlighted by sources like Ameriprise Financial and Million Dollar Journey:

• Risk Management: This is perhaps the most important reason. If certain asset classes (like stocks) perform exceptionally well, they can become a larger portion of your portfolio than intended. This can increase your overall portfolio risk beyond your comfort level. Rebalancing helps manage this risk by trimming overweight positions and bringing your portfolio back to its target risk profile.
• Maintaining Target Asset Allocation: Your initial asset allocation was chosen to align with your specific financial goals, time horizon, and risk tolerance. Rebalancing ensures your portfolio continues to reflect these objectives, even as market conditions change.
• Disciplined Investing Approach: Rebalancing enforces a disciplined, rules-based approach to investing. It helps remove emotion from investment decisions, preventing investors from becoming overly concentrated in assets that have recently performed well (chasing returns) or abandoning underperforming assets prematurely.
• Systematic "Buy Low, Sell High": In essence, rebalancing forces you to sell some of the assets that have performed well (and thus become overweight) and buy more of the assets that have underperformed (and become underweight). This is a systematic way to "sell high" and "buy low," which can potentially enhance long-term returns, or at least risk-adjusted returns.
• Alignment with Evolving Financial Goals: As your life circumstances change (e.g., approaching retirement, change in income), your target asset allocation may need to be adjusted. Rebalancing can be part of this broader review process to ensure your portfolio still suits your needs. (Nasdaq)

Without rebalancing, a portfolio can inadvertently become too risky or too conservative, potentially derailing your long-term financial plans.

3. When to Rebalance Your Portfolio: Strategies and Timing

Deciding when to rebalance is as important as the act itself. There are generally two main approaches, with a hybrid option also popular among Canadian investors (Checkfirst.ca, Million Dollar Journey):

3.1 Calendar-Based Rebalancing

This strategy involves reviewing and rebalancing your portfolio at predetermined regular intervals. Common intervals include:

• Annually: Often done at the beginning or end of the year, or around your birthday. This is a popular and simple approach.
• Semi-annually: Every six months.
• Quarterly: Every three months.

Pros: Simple to implement, requires less frequent monitoring, and encourages a disciplined schedule.

Cons: May lead to unnecessary trading if the portfolio hasn't drifted significantly, or it might not react quickly enough during periods of high market volatility if asset allocations shift dramatically between scheduled dates.

3.2 Threshold-Based Rebalancing (or Percentage-Based)

With this method, you rebalance only when the actual allocation of an asset class deviates from its target allocation by a specific percentage or "tolerance band." For example, if your target for Canadian stocks is 30% of your portfolio, you might set a threshold of +/- 5%. If Canadian stocks grow to represent 36% (target + 6%) or fall to 24% (target - 6%), you would rebalance.

The chosen threshold (e.g., 5%, 10%) depends on your preference and market conditions. A narrower band will lead to more frequent rebalancing.

Pros: More responsive to market movements, potentially leading to rebalancing at more opportune times and avoiding trades when allocations are only slightly off target. Can reduce unnecessary trading compared to a strict calendar approach in stable markets.

Cons: Requires more frequent monitoring of your portfolio (unless automated by a robo-advisor or platform features), and can still lead to frequent trading during highly volatile market periods.

3.3 Hybrid Approach

Many Canadian investors use a hybrid approach, combining elements of both calendar and threshold methods. For example, you might review your portfolio on a calendar basis (e.g., annually or semi-annually) but only execute rebalancing trades if an asset class has drifted beyond a predetermined threshold (e.g., more than 5% off its target).

This offers a balance between disciplined reviews and avoiding unnecessary transactions if the portfolio remains reasonably close to its target allocation.

Ultimately, the best approach depends on your investment style, the time you can commit to monitoring, and your sensitivity to transaction costs and taxes.

4. How to Rebalance Your Portfolio: Practical Methods

Once you've determined it's time to rebalance, there are a few common ways to actually adjust your portfolio's asset allocation (Investopedia, Forbes):

1. Sell Overweight Assets and Buy Underweight Assets: This is the most direct method.
   • Identify which asset classes have grown beyond their target allocation (overweight).
   • Sell a portion of these overweight assets.
   • Use the proceeds from these sales to buy more of the asset classes that have fallen below their target allocation (underweight).
   • This method is common but can trigger capital gains taxes in non-registered accounts.
2. Use New Contributions: If you are regularly adding new money to your portfolio (e.g., monthly savings):
   • Direct your new contributions primarily or entirely towards the underweight asset classes.
   • This gradually brings your portfolio back into balance without necessarily needing to sell existing holdings, potentially minimizing tax events.
   • This method is particularly effective for investors who are still in the accumulation phase.
3. Use Withdrawals: If you are taking withdrawals from your portfolio (e.g., in retirement):
   • Take withdrawals primarily or entirely from the overweight asset classes.
   • This also helps to bring the portfolio back to its target allocation over time, potentially reducing the need for specific sell transactions solely for rebalancing.
4. Combination Approach: You can also use a combination of these methods. For instance, you might direct new contributions to underweight assets and also sell a small portion of significantly overweight assets.

Many robo-advisors and some online brokerage platforms offer automatic rebalancing services, which can simplify this process for investors.

5. Tax Implications of Rebalancing in Canada

Rebalancing can have tax consequences, especially when done in non-registered (taxable) investment accounts. It's crucial for Canadian investors to be aware of these implications (Halifax CityNews, Advisor.ca):

• Capital Gains in Non-Registered Accounts: When you sell investments that have appreciated in value to rebalance, you realize a capital gain. In Canada, 50% of this capital gain (the taxable capital gain) is added to your income for the year and taxed at your marginal tax rate. (Note: Proposed changes in Budget 2024 may alter the inclusion rate for capital gains above a certain threshold for individuals and for all capital gains for corporations and trusts, effective June 25, 2024. Always refer to the latest CRA guidelines.)
• Capital Losses: If rebalancing involves selling investments at a loss, you realize a capital loss. Capital losses can be used to offset capital gains realized in the same year. If you have a net capital loss, it can be carried back three years or carried forward indefinitely to offset capital gains in other years. Be mindful of the superficial loss rule if you plan to repurchase the same or identical security shortly after selling it for a loss.
• Dividend Income: While not directly a rebalancing tax, be aware that holding dividend-paying stocks (which might be sold or bought during rebalancing) generates dividend income, which is also taxable in non-registered accounts (though Canadian eligible dividends receive a favorable tax credit).
• No Immediate Tax Impact in Registered Accounts: Rebalancing within registered accounts like a Tax-Free Savings Account (TFSA), Registered Retirement Savings Plan (RRSP), or Registered Education Savings Plan (RESP) generally does not trigger immediate tax consequences. Sales and purchases made inside these accounts to rebalance do not result in taxable capital gains or deductible capital losses. This is a significant advantage of rebalancing within these accounts.

To minimize the tax impact in non-registered accounts, consider strategies like rebalancing with new contributions, or prioritizing sales of assets with smaller gains or those held for longer periods (to ensure they qualify for long-term capital gains rates if applicable, though Canada doesn't differentiate short-term/long-term capital gains inclusion rates beyond the general rule).

6. Rebalancing in Registered vs. Non-Registered Accounts

The approach to rebalancing can differ slightly depending on whether you are doing it within a tax-sheltered registered account (like a TFSA or RRSP) or a taxable non-registered account.

Registered Accounts (TFSA, RRSP, RESP, etc.):

• Tax-Free/Tax-Deferred Growth: The primary advantage is that selling investments to rebalance within these accounts does not trigger immediate capital gains tax. This allows you to rebalance more freely without worrying about the tax bill from selling appreciated assets.
• No Capital Loss Deduction: Conversely, if you sell an investment at a loss within a registered account, that loss cannot be used to offset gains elsewhere or be claimed as a tax deduction.
• Strategy: Given the tax-sheltered nature, you can rebalance more frequently or with less concern for tax impact if your strategy calls for it. Some investors prioritize holding assets that generate highly taxed income (like interest from bonds) in registered accounts, and assets that generate more favorably taxed income (like Canadian dividend stocks or capital gains) in non-registered accounts (as per TaxTips.ca's general advice on asset location). Rebalancing should respect this overall asset location strategy.

Non-Registered (Taxable) Accounts:

• Tax Consequences: As discussed, selling appreciated assets triggers taxable capital gains. This is the main consideration when rebalancing here.
• Tax-Loss Selling Opportunities: Rebalancing can also be an opportunity to engage in tax-loss selling – realizing losses on underperforming assets to offset gains on other investments.
• Strategy:
  • Consider rebalancing less frequently to minimize taxable events.
  • Prioritize using new cash inflows or outflows to rebalance.
  • If selling, be strategic about which assets to sell (e.g., those with the smallest gains or those resulting in losses if you have gains to offset).
  • Keep meticulous records of Adjusted Cost Base (ACB) for all transactions.

Many investors try to view their entire portfolio (all accounts combined) when determining their overall asset allocation and then decide where to make rebalancing trades based on tax efficiency and transaction costs.

7. Impact of Rebalancing on Investment Returns

The impact of rebalancing on absolute investment returns is a subject of some debate, but its primary benefit is generally considered to be risk management rather than purely return enhancement.

• Risk Reduction: By systematically selling assets that have outperformed and buying those that have underperformed, rebalancing helps to control risk and keep the portfolio aligned with the investor's target risk level. This can lead to smoother returns over time (lower volatility). As Advisor.ca research suggests, rebalancing can reduce volatility and potentially improve risk-adjusted returns.
• Potential for Enhanced Risk-Adjusted Returns: While rebalancing might not always lead to higher absolute returns (in consistently trending markets, a "let winners run" strategy might outperform), it can improve returns relative to the amount of risk taken.
• Disciplined "Buy Low, Sell High": The inherent nature of selling high and buying low can be beneficial, especially in markets that are not consistently trending in one direction.
• Costs of Rebalancing: It's important to consider the costs associated with rebalancing, which can detract from returns:
  • Transaction Costs: Brokerage commissions for buying and selling (though many platforms now offer commission-free trades for certain ETFs/stocks).
  • Taxes: Capital gains taxes triggered in non-registered accounts.
  • Potential Opportunity Cost: Selling outperforming assets could mean missing out on further gains if those assets continue their strong performance.

Research from sources like NBER indicates that while rebalancing is a fundamental tool, prevailing strategies can have market impacts and associated costs. The goal is to find a rebalancing strategy that maintains the desired asset allocation and risk profile without incurring excessive costs or taxes.

8. Portfolio Rebalancing Example (Simplified)

Let's consider a simple example for a Canadian investor:

Initial Situation:

• Total Portfolio Value: $100,000
• Target Asset Allocation:
  • 60% Canadian Equities ($60,000)
  • 40% Canadian Bonds ($40,000)

After One Year (Due to Market Performance):

• Canadian Equities have performed well and are now worth $75,000.
• Canadian Bonds have had modest returns and are now worth $42,000.
• New Total Portfolio Value: $117,000
• New Actual Asset Allocation:
  • Canadian Equities: ($75,000 / $117,000) = approx. 64.1%
  • Canadian Bonds: ($42,000 / $117,000) = approx. 35.9%

The portfolio has drifted. Equities are now overweight (64.1% vs. target 60%), and bonds are underweight (35.9% vs. target 40%). This means the portfolio has become slightly riskier than originally intended.

Rebalancing Action:

To return to the 60/40 target with the new portfolio value of $117,000:

• Target Value for Canadian Equities: $117,000 * 60% = $70,200
• Target Value for Canadian Bonds: $117,000 * 40% = $46,800

The investor needs to:

• Sell $4,800 worth of Canadian Equities ($75,000 - $70,200).
• Use the $4,800 proceeds to buy Canadian Bonds (bringing bond holdings from $42,000 to $46,800).

Result After Rebalancing:

• Canadian Equities: $70,200 (60%)
• Canadian Bonds: $46,800 (40%)

The portfolio is now back to its target 60/40 asset allocation. If this rebalancing occurred in a non-registered account, the sale of equities would trigger a capital gain if their value had increased since purchase.

Canadian Couch Potato provides helpful spreadsheets that can assist with these calculations, especially for portfolios with multiple accounts and asset classes.

9. Common Portfolio Rebalancing Mistakes to Avoid

While rebalancing is beneficial, investors can make mistakes that undermine its effectiveness. Here are some common pitfalls (based on insights from Fidelity and Crain's Chicago Business):

• Not Rebalancing at All: This is the most significant mistake. Letting a portfolio drift indefinitely can lead to unintended risk levels and deviation from long-term goals.
• Rebalancing Too Frequently (Over-Trading): While it's good to be diligent, rebalancing too often (e.g., daily or weekly without significant deviation) can lead to excessive transaction costs and may not provide substantial benefits, especially in taxable accounts where it can trigger more frequent capital gains.
• Ignoring Tax Implications: In non-registered accounts, failing to consider the capital gains taxes triggered by selling appreciated assets can lead to an unexpected tax bill.
• Letting Emotions Drive Decisions: Rebalancing should be a systematic process. Avoid making impulsive changes based on short-term market noise or fear/greed. Stick to your predetermined rebalancing schedule or thresholds.
• Not Having a Clear Target Asset Allocation: Without a defined target mix, it's impossible to know when or how to rebalance effectively. Your asset allocation should be based on a thought-out investment plan.
• Chasing Performance: Resisting the urge to sell winners and buy losers can be hard. Some investors are tempted to let their winning asset classes continue to grow far beyond their targets, increasing risk.
• Focusing Only on Pre-Tax Returns: Especially in taxable accounts, the after-tax return is what matters. Consider the tax impact of rebalancing trades.
• Not Accounting for New Contributions or Withdrawals: These cash flows provide an opportunity to rebalance without necessarily incurring transaction costs or taxes from sales.

Developing a clear rebalancing plan and adhering to it with discipline can help avoid these common errors.

10. Benefits of Portfolio Rebalancing Summarized

Regularly rebalancing your investment portfolio offers several key advantages for Canadian investors, as emphasized by sources like Nasdaq and SmartAsset:

• Risk Management: Ensures your portfolio's risk level remains consistent with your tolerance and original investment plan by preventing overweighting in riskier assets.
• Disciplined Investment Approach: Promotes a systematic, non-emotional strategy, helping you "sell high" and "buy low" by trimming appreciated assets and adding to underperforming ones.
• Alignment with Financial Goals: Keeps your portfolio on track to meet your long-term objectives by maintaining your desired asset allocation.
• Adaptation to Market Changes: Allows your portfolio to adjust to evolving market conditions and valuations across different asset classes.
• Potential for Enhanced Risk-Adjusted Returns: While not guaranteeing higher absolute returns, rebalancing can improve the overall return you get for the amount of risk you take.

11. Risks of Not Rebalancing Your Portfolio

Failing to rebalance your portfolio can introduce several risks that may jeopardize your long-term investment success (Raymond James, IWillTeachYouToBeRich.com):

• Increased Risk Exposure: Your portfolio can become significantly riskier than intended if high-performing, more volatile assets (like stocks) grow to represent a much larger portion of your holdings than your target allocation allows. This was evident for many during the tech boom of the late 1990s.
• Misalignment with Financial Goals and Risk Tolerance: As your portfolio drifts, it may no longer reflect your original investment objectives or your comfort level with risk, especially as your life circumstances (e.g., approaching retirement) change.
• Reduced Diversification Benefits: An unbalanced portfolio can become overly concentrated in certain assets or sectors, diminishing the protective effects of diversification and making you more vulnerable to specific market downturns.
• Potentially Lower Long-Term Returns: By not systematically taking profits from outperforming assets and reinvesting in undervalued ones, you might miss opportunities or be harder hit during market corrections.
• Emotional Investing Decisions: Without a disciplined rebalancing strategy, investors may be more prone to making reactive, emotion-driven decisions during market volatility, such as panic selling during downturns or chasing trends when assets are already overvalued.
• Unexpected Tax Consequences Later: While rebalancing can trigger taxes, letting a portfolio become heavily concentrated in highly appreciated assets can lead to a very large tax bill when those assets eventually need to be sold.

Regular rebalancing acts as a crucial course correction, helping to mitigate these risks.

12. Conclusion: Keeping Your Investments on Track

The Discipline of a Balanced Portfolio

Portfolio rebalancing is a vital discipline for Canadian investors aiming to achieve their long-term financial goals while managing risk effectively. By periodically realigning your investments to your target asset allocation, you ensure your portfolio remains consistent with your risk tolerance and investment objectives, rather than being dictated by the whims of the market.

Whether you choose a calendar-based, threshold-based, or hybrid approach, the key is to have a plan and stick to it. Remember to consider the tax implications, especially in non-registered accounts, and leverage the tax efficiency of registered accounts like TFSAs and RRSPs when rebalancing. By making rebalancing a regular part of your investment routine, you can navigate market fluctuations with greater confidence and keep your financial future on a steady course.

Key Resources for Canadian Investors:

References (Illustrative)

This section would typically cite specific academic studies, white papers from investment firms, or detailed guides used in preparing the content.

• Vanguard. (2020). *The Value of Advice: Assessing the Role of Emotions*.
• PWL Capital. Research on portfolio rebalancing.
• NBER Working Paper Series. *The Unintended Consequences of Rebalancing*.
• Financial Planning Standards Council (now FP Canada) guidelines on portfolio management.