Rebalancing Brightens Your Future

By: AARP Education & Outreach | Source: AARP.org | April 7, 2009

“Digging up my bountiful daylily bed might seem counterintuitive, but it’s something that has to be done periodically.” So says Sally Hurme, a West Virginia gardener whose daylily garden started with a few tubers transplanted from her mother-in-law’s garden a decade ago. “The plants multiply so fast that they can overrun my garden, so it’s best to dig them up from time to time. Sometimes I like to add new flowers to add color and variety,” Hurme says.

Rebalancing your investment portfolio can also seem counterintuitive. Why should you sell some stocks or bonds that are doing well just because your mix of assets moves away from your target? Charles Alkire, CFP®, an independent financial advisor in Sarasota, Fla., gives several good reasons:

• If the value of the stocks in your portfolio increases, the ratio of stocks to bonds could change. Over time, you could end up with more risk than you want. Conversely, if your stocks go down in value, you could have investments that are too conservative for your needs.
• When some of your investments become clustered too tightly, you lose the benefit of diversification.
• Rebalancing can also give your portfolio an overall lift. You can move your investment dollars into asset classes that are underperforming now but may perform better in the future.
• It’s always better to buy low and sell high. Rebalancing forces you to sell investments that have gone up in value. You’ll lock in profits rather than trying to squeeze out more returns by holding on just a little longer.
• Automatic rebalancing takes the emotion out of investing.
• Your investment goals, as well as the market, change. When you review your asset allocation, you ensure that your investments are in line with your needs.

You have four ways to rebalance. Let’s say that you determined that you wanted 60 percent of your portfolio in stocks, 30 percent in bonds, and 10 percent in cash. During the past year, your percentage of stocks has increased to 65 percent of your portfolio. You could sell off some stock that has increased in value and invest the profits in bonds and cash until your original percentages are achieved. Or you could sell any underperformers to generate the cash to invest in your other asset classes. Your third option would be to invest new money into your portfolio in the bonds and cash portion to bring those percentages up to the level you want. If you are making continuous contributions to the portfolio, you can alter those so that more investments go to under-weighted asset categories until your portfolio is back in balance. You might consider investing in a mutual fund that provides instant diversification and automatically rebalances at preset times. Many mutual fund companies offer asset allocation funds that automatically rebalance at preset times. Remember, too, that if you are rebalancing taxable investments, there could be tax consequences (short- or long-term capital gains or losses) with each transaction.

“Just as I need to divide my lilies periodically when they get too crowded, I also need to revisit and change my investment mix from time to time,” says Hurme.

The Securities and Exchange Commission suggests that you rebalance your portfolio based either periodically or on when your investment advisor tells you. It might be easier to remember if you plan to check on the need to rebalance every six or 12 months. Quarterly visits with your financial advisor are a great time to review the balance of your portfolio. The American Savings Education Council suggests that you use the receipt of your annual Social Security statement as a reminder to revisit your investments. Another tip is to let your investments tell you to that it’s time to rebalance. When the percentage of an asset class increases or decreases significantly, that is a good signal to rebalance.

This article is meant to provide general financial information; it is not meant to substitute for, or to supersede, professional or legal advice.