Rebalancing

ONCE YOU SETTLE ON target portfolio percentages for stocks, bonds, cash investments and alternative investments, you’ll want to check where you stand at least once a year and also after major market moves. Why? You may find you have drifted far from your target percentages.

Let’s say you earmarked 50% of your money for stocks and 50% for bonds. Stocks then plunge 20%, while bonds climb 10%. Result? Your 50-50 mix would now be 42% stocks and 58% bonds. To get back on target, you should rebalance. If you’re dealing with a tax-sheltered retirement account, you might sell some bonds and purchase stocks. But with a taxable account, any selling could trigger capital gains taxes, messy tax accounting and possibly trading costs. Instead, you might try to rebalance within your taxable account by directing new savings, as well as any dividend and interest payments, to the stock side of your portfolio.

This rebalancing will keep your portfolio’s risk level in line with your targets. If stocks have declined, it can also set you up nicely for any market rebound by ensuring you have a full position in stocks.

But much of the time, you will probably find yourself cutting back on stocks. This will ensure you aren’t hurt excessively by the next market downturn, but it will likely also crimp your long-run return, because you are selling what should be your best-performing investment. That said, rebalancing has the potential to enhance returns—especially if you’re rebalancing among stock market sectors or among bond market sectors. We’ll discuss that later in this chapter.

Next: Rebalance How Often?

Previous: Volatility Hurts

Articles: Balance Issues, Harder Than It Looks, Resolve to Rebalance and All the Right Reasons