The Ultimate Rebalancing Strategy: The Top Two Ways to Create Portfolio Stability Next Year

For investors looking to move some capital in the coming year, there are certain strategies that can be implemented. It’s generally a good idea to rebalance your portfolio from time to time. Personally, I try to do this every quarter, but the end of the year is one of the most important times when I take a good look at how my investments are doing.

It is important to ensure that one has sufficient exposure to the key trends that he or she wants to invest in over the coming year, while also balancing their risk/reward profile. We all have unique risk profiles and growth objectives, so we need to tailor our positions to our preferences for the year ahead.

Here are two top strategies that I personally use when rebalancing my portfolio and would encourage other investors to consider.

It’s time to renew your valuation models

Stocks are generally valued as the discounted sum of all future long-term cash flows. In other words, as long as a business is in business, its future cash flows are attributable to its owners. As a shareholder in a company, you are entitled to these cash flows (which are either reinvested in a company’s core activities or ultimately paid out as dividends).

So it’s important to revise your Discounted Cash Flow (DCF) model annually or quarterly with new growth assumptions. Is a company expected to grow faster in the coming years because of its AI integrations? Or is price pressure due to bearish market dynamics likely to result in slowing growth?

The other important input into such models is the expected future ‘risk-free rate’, which is used to discount these cash flows to the present day. Typically the interest rate on 10-year US government bonds or 5-year Canadian bonds. These interest rates are important to estimate and are changing rapidly. That’s why I prefer a quarterly model review, but it’s up to each individual investor to decide what’s best for him or her.

Sector allocations

The other key factor that I think is important to highlight is which specific sectors people are looking to invest in over the course of the next year and how that aligns with their long-term growth expectations.

Personally, my investments don’t change much, although I have noticed that technology exposure, simply by running some winners, has become an increasingly important part of my portfolio. And because I primarily own ETFs, that means it’s important to look at international funds and other individual stock picks in sectors I want exposure to.

I think even passive investors who invest primarily in index funds (like myself) should consider adding sector-specific ETF exposure to other areas that they think could outperform in the coming years outside of technology. Given the rally we’ve seen in certain parts of the economy, I think this is the sensible thing to do now.