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Is your portfolio out of whack?

September 30, 2011

| MoneyRates.com Senior Financial Analyst, CFA

Set it and forget it is not the right strategy for managing your portfolio, especially when the markets have been so volatile. October 3-9 has been designated as Financial Planning Week by the Financial Planning Association. Events like that are good reminders to take care of periodic financial maintenance tasks, like rebalancing your portfolio. As it happens, recent market volatility has created some ideal conditions for that kind of rebalancing.

Why should you rebalance your portfolio? Here are five possible reasons why a portfolio should be rebalanced, some of which apply in particular when the market has been as turbulent as it has been recently:

  1. Your goals may have changed. You're another year older, and possibly another year closer to retirement. Does that dictate that you shift more heavily into income-producing bonds, or direct more money in savings accounts or money market accounts? Have births, deaths, marriage, or divorce altered your savings needs? Has the loss of a job forced you to tap into savings sooner than you'd planned, or has a raise in pay made more money available for saving? The point is, a variety of events, or just the passage of time, can alter your financial goals. There's no point in adjusting those goals if you don't adjust your portfolio along with them.
  2. Your asset mix may have shifted. You can set an asset mix in accordance with your goals, but those assets won't march in lock-step toward those goals. Especially in a volatile investment environment, you are likely to see some assets doing much better than others, and that may have thrown your asset mix out of whack enough to dictate rebalancing. For example, despite its recent setbacks, the S&P 500 was actually up more than 16 percent for the year ending August 31, 2011. Meanwhile, conservative vehicles such as T-Bills, savings accounts and money market accounts are virtually where they were a year ago. Has this caused your stock allocation to become too heavily weighted? If you own gold or other commodities that have soared over the past year, you may want to take this time to trim those positions. For example, gold is up more than 45 percent over the past year. That's great if you own gold, but you want to guard against anything so volatile becoming too big a portion of your holdings. Ultimately, that's one of the great values of rebalancing--it reminds people to buy low and sell high.
  3. Investment fundamentals may dictate a change in asset mix. Much of the classic thinking about asset allocation was formulated at a time when interest rates were 5 percent or higher. Now, savings and money market rates are less than 0.20 percent, and even 30-year Treasury bonds are barely above 3 percent. This may require you to change your assumptions about investment returns and income production, and your portfolio may have to change along with those assumptions.
  4. Price disruptions can create upgrade opportunities. There are certain companies that are widely admired as leaders in their industries, such as Apple, Google, Southwest Airlines, Coca Cola, etc. The problem is, opportunities to buy an outstanding company at a reasonable price are rare. So portfolios often have to buy lesser companies which may represent better investments simply because their valuations are cheaper. However, in times of market disruptions, stocks may be down across the board, creating rare opportunities to upgrade your holdings into those most admired companies at reasonable prices. You'll want to take a close look at valuations before you act--just because a stock is down doesn't make it cheap. However, the greater the market disruption, the more likely you are to find outstanding companies at bargain prices.
  5. Under-performing strategies should be weeded out. If you use a mutual fund or investment manager, or even if you employ certain strategies of your own, you need to periodically review the performance of these investment approaches and get rid of those that aren't working. Evaluate investment performance against relevant benchmarks, and over full-market cycles of rising and falling periods. Otherwise, you will have a tendency to hire hot managers or funds just as their styles may be going out of favor. Besides looking at investment performance, research whether there have been any organizational or personnel changes that might diminish a fund or manager's effectiveness. In short, rebalance your portfolio so that it is being handled by managers, funds, or strategies with proven, long-term records of success and stability.

Finally, rebalancing a portfolio is a reminder to pursue a goal-based investment strategy. Making that kind of purposeful move might help you steer clear of the more emotion-driven changes investors tend toward when markets get choppy.


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