Rebalancing Your Portfolio

Rebalancing Your Portfolio

As the trend continues for carrying more of the responsibility for your retirement nest egg, you will have to make investment decisions all along the way. Some will seem brilliant at the moment you make them, only to turn to dust in hindsight. You will be challenged to stay on top of what is happening in your portfolio and to make adjustments periodically to reflect your goals. It doesn't hurt to get good professional advice before you throw all your retirement dollars into the hot stock that cousin Joey was tipped to on his last fishing trip with the guys.
When you make investment decisions, and watch them, you will see movement over time both up and down financially. Every now and then you may want to switch where you have your dollars placed in order to hit a target you have for your retirement plan. This is known as rebalancing your portfolio. This is how it works: Your initial objective was to have 10 percent of your portfolio be in government bonds. Because of a strong stock market over a couple of years, your bond percentage drops to 7 percent. Now you would sell some of the assets that had grown and purchase more of the government bonds to keep your overall portfolio balanced as you envisioned.
You may be wondering about how to decide when to rebalance. There are two methods — calendar and conditional. With calendar rebalancing, you set a periodic time frame, either quarterly or annually, and you will sell some of the investments that have gone up and buy more that have gone down. These decisions can be made by category rather than by specific securities. Conditional rebalancing is put into action whenever an asset class goes up or down a percentage you choose, usually a significant swing—25 percent, for example. This method lets you respond to the market rather than the calendar.

Investment Risk and Mix

Let's take a closer look at how you will build the portfolio you will be rebalancing. As you move through your working years, you may have a number of opportunities for putting away money for your retirement. After a decade or more, you might find yourself with an IRA you set up with monies from summer jobs while you were still in school (a really good idea, by the way), a 401(k) one of your employers offered, and a Roth IRA you decided to open. You may have company stock in the employer's plan, and a combination of cash and mutual funds in your IRAs. By chance you have a mix of investments, which is a good thing. The more you are building your investments as you are salting away money for retirement the more deliberately you will want to diversify where your money is going. Your goal should be twofold. First, you should aim to spread your investments among categories. Then, aim to diversify within each category.
The primary reason for diversifying your investments is because at any point in time one type will be doing well while another lags. Often when stocks are booming, bond prices sag. Over the course of a long period of savings, the ups and downs smooth out.

Try to spread your money among cash, bonds, stocks, and some other types of investments. Studies demonstrate that once you have decided which categories you will use, the choice of how much to put in each is the most important factor in your personal investment strategy.

Within each category you will want to diversify. For example, you may put cash in CDs with different maturing periods and different rates of interest. You may choose bonds in an IRA that will have taxes due when you begin to make withdrawals. You may hold individual company shares or you may opt to spread your stock dollars in a couple of mutual funds. Multiple stock funds are usually managed by professionals who watch many industry stocks and make decisions for the fund based on the goals of the fund. Some funds are designed to be high risk/high growth and others just the opposite. Make it your business to know where your monies are going and what the goal is for each investment.
The bottom line is: Don't put all your eggs in one basket. When you diversify into various types of assets, your risk will more likely be reduced and your returns should be stronger than if you had limited your choice to only one investment, or even one type of investment.

Asset Allocation

How you actually divide up your investments is called asset allocation. If you decide cash is to be part of the mix, what percentage is right—15 percent? 25 percent? The same questions apply to each segment — should you have 50 percent of your portfolio in stocks? Should half of that be in mutual funds and half in individual company shares? What about bonds? The key factors influencing this choice will be:

• How much time you have until you retire
• The size of your current nest egg
• How long you expect to live
• How much risk you are willing to take
• What other sources of retirement income you have
• The state of your current financial health

Over time your asset allocation is apt to change. In your earlier years it may make sense to load up on stocks and mutual funds instead of sitting on a pile of slow-growing cash, or conservative bond funds. As you progress closer to retirement, you might gradually shift the allocation of your investments from the higher stakes of stocks to the more predictable sure bets of bonds and treasuries. You may wind up changing your asset allocation because your financial circumstances have changed, or your goals and risk tolerance have changed.

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