Ride the bull market to the top and then ride the bear market all the way down: It's a poor investment strategy, yet financial advisors say it's a common occurrence for do-it-yourself (DIY) investors who don't adhere to a fundamental investment principle: rebalancing.
It's a particular problem when certain stocks or sectors see a huge price increase and investors are reticent to sell.
"[Some investors] forget or are reluctant to take profits because they have this idea that an investment will keep going up," says Amy Dietz-Graham, a portfolio manager with the Durkin Dietz Group at National Bank Financial Wealth Management in Toronto.
Investors are taking on more risk by failing to rebalance, she says, especially if the investment declines in value. They may also miss the opportunity to reallocate to assets that may be undervalued and poised for a rebound.
A classic asset allocation for many investors is a portfolio made up of 60 per cent stocks and 40 per cent bonds. However, that mix will vary depending on an investor's age, time horizon to their financial goal - such as buying a home or retirement - and their risk appetite. For instance, someone in their 30s or 40s with a longer time horizon may choose a portfolio of 80 per cent stocks and 20 per cent fixed income.
A DIY investor's asset mix can drift away from their target, especially when a particular stock or sector either over- or underperforms.
Tyler Haw, customer engagement and education lead for Questrade in Toronto, says many DIY investors have little or no diversification.
"I don't see too much in the way of our clients investing in fixed income," he says, as one example.
He says their investing journey often starts with owning a handful of popular stocks and, over time, those positions grow and they're reluctant to trim them.
"It's hard to cut top-performing investments, but if you don't and that stock takes a big hit, those big profits might disappear," Mr. Haw says.
Risk appetite and asset selection "is the only thing investors can control with certainty" to stay on track with their financial goals, says Danielle Martin, a portfolio manager with ScotiaMcLeod, a division of Scotia Capital Inc., in Toronto.
But for DIY investors, it requires regular check-ins on their overall portfolio.
"When someone is do-it-yourself, it's much more work to rebalance and take profits, because it's an emotional decision," Ms. Martin says.
She says rebalancing also provides investors with "a smoother ride," citing a 2018 study by the U.S.-based asset manager Research Affiliates that found systematic rebalancing results in higher long-term risk-adjusted returns.
"If something goes wrong and you've got an investment that has soared in the portfolio, you're going to feel its downside much more than if you had pared back the position as part of your process to rebalance regularly," Ms. Dietz-Graham says.
Ms. Martin says a rule of thumb for DIY investors is to rebalance twice a year, if necessary. For example, if someone with a target of 50 per cent stocks in their portfolio sees that allocation drift to 55 or 60 per cent, they should consider trimming top-performing positions and allocate that capital to other assets underweight in the portfolio.
DIY investors can buy automated diversification and rebalancing with the growing number of all-in-one portfolio exchange-traded funds (ETFs) and mutual funds available today, notes Ms. Dietz-Graham.
She says investors who find rebalancing challenging might consider working with an advisor who can do it for them. Advisors also manage some of the complexities of rebalancing such as tax implications on realized capital gains when trimming top-performing investments in a non-registered portfolio.
"[Investors] are smart and could do it themselves, but they recognize they don't have the time to do it consistently, so they hire advisors and they're often rewarded long-term for doing that," she says.
Ms. Dietz-Graham says investors also turn to advisors to help them avoid potentially irrational decisions, such as panic selling or buying more of a security that doesn't fit their financial plan.
"It's removing the emotion," Ms. Dietz-Graham adds, noting discretionary managers such as her often have clients who have automated, well-diversified model portfolios that rebalance more frequently than twice a year.