It’s time to review, rebalance investment portfolios

Published 12:00 am Sunday, January 10, 2010

Given the remarkable turnaround in the stock market in the latter months of 2009, the annual ritual of reviewing and rebalancing portfolio assets has taken on new significance for the individual investor.

What Is Rebalancing?

It is important to understand that your investment mix (known as your asset allocation) is always subject to change. That’s because investment performance could cause the value of some assets to rise (or fall) more than others. When an asset allocation changes in this way, investment professionals often say it has “drifted” or become unbalanced. In that event, you may need to rebalance your asset allocation so that it again has the risk and return potential you desire.

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One way to rebalance involves selling investments in the asset class that currently exceeds your allocation target. Another is to buy investments in the underperforming asset class or to use new money to increase the underweighted asset. Or you may opt for a combination of those strategies.

Many investors dislike rebalancing because it means selling winners in favor of losers. Rebalancing can also generate transaction fees, as well as taxes on gains created by selling securities. (See the Money-Saving Tips below.) Nonetheless, most financial professionals believe the advantages of rebalancing outweigh the disadvantages.

Allocation Drift: An Example

To appreciate how performance differences can affect an unbalanced portfolio over time, consider what happened to a hypothetical portfolio consisting of 70 percent domestic equities, 10 percent foreign equities, 10 percent U.S. government bonds and 10 percent cash instruments. Left unbalanced for the 20-year period ending Dec. 31, 2008, the original 70 percent allocation to U.S. equities had grown to 76 percent, while the other allocations shrank, reducing their intended risk reduction role in the portfolio. As always, past performance is no guarantee of future results.

Consider the Big Picture

If you have multiple investment accounts, determining whether to rebalance may involve several steps, beginning with a check of your overall allocation. This entails figuring how your money is divided among asset classes in each account and then across all accounts, whether in taxable brokerage, mutual fund or tax-deferred accounts.

To gain a full appreciation of your investment strategy, go beyond stocks and bonds and calculate the percentages you have in other asset classes, such as cash and real estate. In addition, you may want to evaluate your allocations to categories within an asset class. In equities, for example, you might consider the percentages in foreign versus domestic stocks.

William McDonough is an investment representative associated with LPL Financial. He can be reached at 601-446-6767. Securities Offered Through LPL Financial. Member FINRA/SIPC.