If you feel lucky having come through the past 18 months with your investment portfolio relatively intact, you might figure now’s the time to breathe easy.
You’d be wrong.
While the stock market has taken some big steps toward recovering from the beating it took in the fall of 2008, and the economy appears to be stabilizing and even growing, investment experts say rebalancing your portfolio — changing the mix of stocks, bonds and cash — is as important now as it ever was.
“It’s really important to understand how your asset allocation changes throughout the year, especially in times of heightened market volatility, which is clearly the situation we’ve been in for the last year and a half,” says Chris McDermott, vice president of marketing product management at Fidelity Investments in Boston. “Assuming you know what your investment benchmark goals are, you need to look at how your investment mix changes as the market changes.”
McDermott recommends rebalancing — or at least considering it — at least once a year.
“Review it quarterly, and rebalance at least annually. It shouldn’t necessarily be calendar-based, but instead based on whether you’ve moved away from your benchmark,” McDermott says.
Where to start
The first step is establishing your benchmark asset allocation, or the percentage of your assets that you want to invest in stocks, bonds or cash, and adjusting it as time passes. For example, your tolerance for risk is likely to be higher the further you are from your investment goal, whether it’s for retirement or for paying for your child’s college education.
If you’re a couple of decades away from those events, your tolerance for risk, and therefore your tolerance for the fast-changing equity markets, may be higher, McDermott says. As retirement or college gets closer, you may want to have your portfolio more heavily weighted toward bonds and short-term investments. Volatility might drive you toward cash at that point.
Investors who are looking for aggressive growth might consider a portfolio that is 70 percent in domestic stocks, 15 percent in foreign stocks and 15 percent in bonds, according to Fidelity. Fidelity gives a sample set of benchmarks on Fidelity.com.
As your goal date moves closer, Fidelity suggests a reallocation, ending up with 50 percent of your portfolio in bonds, 30 percent in short-term investments and 20 percent in domestic stocks.
Tinkering with that mix at least annually is the key to keeping your goal on track.
If your asset mix is 10 percent off target, your balance is likely to be off as well. For example, you open your statement and see that your stocks did very well last quarter, but your bonds languished. That’s when it’s time to rebalance, McDermott says.
“You want to get back to your target mix,” he says.
Christopher Davis, a fund analyst at Morningstar in Chicago, agrees that it’s important to keep your balance in line, although he thinks annually is probably often enough.
“A better approach is to rebalance when your asset allocation gets seriously out of whack,” Davis says. “If you set up a rule for yourself that says, ‘When my equity weight is 5 percent greater than my target, maybe that’s when (I) rebalance.’ … It does give you the chance to let your winners run a little bit, and it helps you reduce your transaction costs.”
Stick to your plan
Davis points out that if you rebalance too often, you run the risk of generating more taxable gains as well as higher brokerage costs.
Like McDermott, Davis is a believer in having a plan.
“Often, inaction is better than action when you have a good plan to begin with,” Davis says.
But that’s only if the markets are in sync with your mix. John Bajkowski, a financial analyst at the American Association of Individual Investors in Chicago, says checking your portfolio regularly and keeping your asset allocations up to date are important, and so is patience.
“It’s very important to have a long-term financial plan in place and try not to get too bogged down in the short term,” Bajkowski says. “Take the big picture view and make sure you’re comfortable dealing with market extremes.
“It’s always easy when things are going well, but the market has tested us lately, and the people that panicked at the end of last year and sold off their equity positions are now probably sorry they did so,” Bajkowski says. “That’s why you need to have a long-term plan in place, and stick with it.”
Rebalancing often has tax implications. For example, selling a high-performing investment could cost you in capital gains taxes on the profit you’ve made. Plowing those profits back into your portfolio could be more beneficial.
Do it yourself?
Bajkowski says investors can rebalance their portfolios on their own, and you can find tips on the American Association of Individual Investors Web site.
Nancy Mobberley, a Certified Financial Planner and owner of Financial Investment Network Inc. in Palm Beach Gardens, Fla., agrees that rebalancing can be a DIY project, but not everybody has the stomach for it.
“I have clients tell me they won’t even open their statements,” Mobberley says. “I tell them to at least take a look at it. You don’t have to worry over it, but you need to know what you’ve got, and what it’s doing.”