The U.S., Canadian, and Rest of World equity markets are down around 30% in less than a month. This is a quick and violent decline. Quick and violent declines happen and will happen again. Meanwhile, Canadian fixed income is down around 6.5% in the same period. Canadian fixed income has outperformed Canadian and global equity. What is the proper response?
We know what we are supposed to do. We rebalance out of fixed income into equity.
Let’s perform a little simple arithmetic. We assume a $100,000 portfolio with a thought-out asset allocation of 60% equity and 40% fixed income. The asset allocation was appropriate before the Corona crash and there is no reason that it isn’t appropriate now. As of now, the $60,000 balance in equity is worth $42,000 and the fixed income is worth $37,200 for a total portfolio of $79,200. That is a $20,800 loss in less than a month. Investing can be painful.
Rebalance because market declines have moved the portfolio off its target allocation. The portfolio holds $42,000 / $79,2000 = 53% in equity and 47% in fixed income. We need to move ($79,200 x 60% - $42,000 =) $5,520 out of fixed income to equity to achieve the 60 / 40 target asset allocation.
It is easy to rebalance when equity markets are performing well. It is scary to rebalance when equity markets are behaving badly but it must be done. Remember, rebalancing is a buy low / sell high strategy. We are buying at what is now a 30% discount to what it was three weeks ago. If it was handbags or power tools, we would be thrilled.