Keep your portfolio in balance with an annual review
Published 12:00 am Sunday, November 25, 2007
Your target asset allocation, or the mix of stocks and bonds you have chosen to pursue your investment goals, provides the foundation for your financial plan. However, even the most appropriate asset allocation may be driven off-track by a number of factors, including bouts of market volatility. Given the turbulence that has prevailed over the stock market during much of 2007, now may be an ideal time to determine whether recent market performance has affected your asset allocation’s “balance.”
A portfolio review should be an integral part of an annual financial review that examines all aspects of your financial life — from income and expenses to college and retirement planning, taxes and estate plans. The goal of such a comprehensive review is to identify any important changes in your life and plan accordingly for the coming year.
The first step in conducting a portfolio review is to calculate the percentage of your assets that is invested in stocks, bonds and other asset classes. Next you will need to decide whether you are comfortable with those allocations or whether you need to “rebalance” your investment mix to bring the allocations back to their original intended targets.
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For instance, suppose that your portfolio is currently a mix of 70 percent stocks and 30 percent bonds, but you’d prefer a 60/40 mix. One way you could adjust your allocations would be to sell some of your stock investments to attain the desired 60 percent allocation. Or you could do the opposite and add more bonds to your portfolio. Keep in mind that there may be taxes, fees and strategic considerations associated with either option, so be sure to consult with a trusted investment and/or tax professional before making any decisions.
Portfolio drift: An example
To illustrate how investment performance can affect a portfolio over time — pushing it more and more out of sync with its original allocations — consider what would have happened to a hypothetical portfolio left unbalanced for the 20 years ended June 30, 2007. What began as a 70 percent allocation to U.S. stocks would have grown to 83.31 percent of the portfolio, while 10 percent allocations to government bonds, foreign stocks and money market instruments would have shrunk, reducing their intended risk reduction role in the portfolio.
Bonds haven’t been as volatile as stocks over long periods of time, but recent history shows that they too can experience performance patterns that may alter asset allocation. Consider the divergence of the stock and bond markets between 2000 and 2002 and how that may have affected asset allocations. While the S&P 500 returned -9.1 percent in 2000, -11.9 percent the following year and -22.1 percent in 2002, long-term U.S. government bonds gained 20.3 percent in 2000, 4.3 percent in 2001 and 17.0 percent in 2002.
Likewise, the performance dynamics of various styles of equities — e.g., small-cap stocks, foreign stocks, growth and value stocks — can effect your overall asset allocation when left unchecked. As an example, large-cap value stocks have outperformed large-cap growth stocks by an annualized pace of about 12 percent since March 2000 (as measured by Russell 1000 Growth and Russell 1000 Value). This seven-year run would have left a portfolio that has not been rebalanced tilting heavily toward value stocks — and positioned poorly in terms of performance and risk — as the cycle shifts back toward growth.
Life and lifestyle changes
Market volatility is not the only factor that may cause you to rethink and rebalance your investment mix. Any new circumstances in your life or changes in your lifestyle may necessitate a reshuffling of assets.
For example, getting married and starting a family are two events that are likely to create a whole new set of high-priority financial needs. Or maybe your change was of a different nature: Did you get divorced, take a new job or embark on an entirely new career? Have you experienced a financial windfall? Did a loved one pass away? Maybe one of your children got married. Or perhaps you’ve become a grandparent. Each of these events — and others like them — will probably require you to reevaluate and enhance each of your strategies for pursuing all-around financial well being.
How often should you rebalance? The usual answer is anytime your goals change; otherwise, at least once a year. However, to keep close tabs on your investment plan and make sure it doesn’t drift far from your objectives, you and your advisor may prefer to set a percentage limit of variance, say 5 percent on either side of your intended target, that would trigger a review and possible rebalancing.
Working together toward your goals
Although rebalancing your portfolio can be challenging, it is generally the best way to stay focused on stated goals. By working closely with a trusted advisor who understands your life goals and offers ongoing advice in support of those goals, you will have a much better chance of keeping your financial plans on track — whatever life or the investment markets send your way.
Bazile R. Lanneau Jr. is a Financial Advisor with and offers securities through Linsco/Private Ledger (Member FINRA-SIPC).