Rebalancing your portfolio is one of the keys to successful investing over
time. Rebalancing means adjusting your holdings—that is, buying and selling
certain stocks, funds, or other securities—to maintain your established asset
allocation. For example, let's say your asset allocation is 60 percent stocks
and 40 percent bonds. If stock prices go up for a few months, your allocation
to them might rise to 70 percent. That means you have to sell some stocks to
get back to your desired level. It's important to maintain your asset
allocation because it keeps your tolerance for risk at the most comfortable
For most investors, rebalancing twice a year is sufficient to make sure
their asset allocation isn't getting out of whack. Mark the dates you want to
rebalance on a calendar you check the most. That way you won't forget.
Here are three reasons why rebalancing is important:
Rebalancing forces you to take profits from investments that have
run up and put money in things that have merit but haven't gone up.
When one piece of your pie goes up, you might get greedy and want to put more
money in it. You need to fight that urge. Actually, the best thing you can do
is take profits from your winners from time to time.
A good rule of thumb for when it's necessary to rebalance is when an asset
class weighting has changed by five percentage points. Let's say your
allocation in small-cap stocks rises from 15 percent to 20 percent. If you
don't trim your small-cap holdings back to your 15 percent target allocation,
the risk in your investments is increased. In other words, if small-caps
suddenly start falling, 20 percent of your portfolio will drop with them rather
than 15 percent.
On the flip side, your allocation in international stocks may have dropped
from 20 percent to 15 percent. That means prices have dropped, presenting a
buying opportunity. Look for assets that stand to rise in price in the future.
Ask your adviser for help if you don't feel comfortable researching areas of
the market on your own. Remember, you want to buy low and sell high, not the
other way around.
Rebalancing gives you the opportunity to review all of the mutual
funds in your portfolio. While you're examining the changes in your
investment allocations, you can also evaluate your funds. If a fund you own has
risen 10 percent, you could be too concentrated in one fund. You might want to
take those profits and buy a second strong fund in the same asset class.
In addition, you can search for a better fund if one is not living up to
your expectations. With so many good funds available, there's no reason to hold
on to a fund if you're not happy with it. Check U.S. News's Best Funds site, Morningstar, or other financial sites to
research funds or seek advice from your financial adviser.
Rebalancing smooths investment returns. All asset classes
go through cycles. Professional investors will pile into tech stocks or love
anything related to gold. Then before you know it, they hate them and move on
to the next best thing. Most people aren't lucky or smart enough to get in the
best sector or certain stocks at the right time and then switch into other ones
when prices are the most attractive.
That's why dollar-cost averaging works well for many investors. Dollar-cost
averaging means putting a set amount of money in investments (usually stocks
and mutual funds) every month over a long time period. No matter the price of
the investment, you're buying $100 (or some other set amount) worth of shares
each month. When prices are higher, you buy fewer shares. Conversely, you buy
more shares when prices are lower. As a result, your average cost per share
will reflect both the discounted prices during a bear market and the premium
prices during a bull market, rather than just the premium prices.
The beauty of dollar cost averaging is that you don't have to figure out
when to get in and out of any area of the markets. It gets you in the habit of
investing every month, so the value of your account will increase over time.
You may not realize this, but if you're putting money into a retirement plan at
work or a brokerage account every month, and those contributions are programmed
to make regular purchases of specific securities, you're using dollar-cost
Ultimately, dollar-cost averaging and rebalancing regularly smooths returns
during bumpy markets. You may not generate the largest gains during a rising
market, but you may not get hit as hard in falling markets. If you stick with
your asset allocation and periodically rebalance, you can generate a decent
average return over time.
By Adam Bold Source www.USnews,com