It’s a temptation reinforced by investment experts: Establish an investment portfolio and don’t mess with it.
That does not mean that you should forget about it.
“The market keeps moving,” said John Rhoads, senior partner and money manager at Rhoads Grunden Lucca Capital Management in Dallas. “The market is a living thing.”
And it can wreak havoc with the balance of your investments.
So it’s crucial that you review your portfolio at least once a year to determine whether you need to “rebalance” or adjust your holdings.
That simply means seeing whether your money is still divvied up among stocks, bonds and cash in the proportions you originally intended.
Given the volatility in the stock market in the last year, there’s a strong possibility that your portfolio has been thrown out of whack to the point that it’s no longer compatible with how much investment risk you want to shoulder.
“That original perfect program that you designed for yourself is completely different a year out,” Rhoads said. “If 25 percent of your portfolio five years ago was in high-tech stocks and you never touched that portfolio, you’ve probably got 50, 60 percent of technology now. The question is, do you want that?”
Your decision about whether to rebalance can have a major impact on your portfolio.
Here’s an example from Ibbotson Associates in Chicago, a finance industry consulting firm:
Say you invested $100,000 at the beginning of 1999, with 60 percent in the Nasdaq 100 (which consists primarily of large growth stocks, with a strong tilt toward technology) and 40 percent in long-term government bonds.
At the end of 1999, the Nasdaq soared 85 percent, but bonds had lost about 2 percent in total return.
Because you had more than half of your $100,000 in the Nasdaq, your portfolio would have grown to $150,640 at the end of 1999 from the beginning of that year.
At the same time, the proportion of money invested in the Nasdaq would have increased to 74 percent from 60 percent, while the proportion of money in bonds would have fallen from 40 percent to 26 percent.
“Because the Nasdaq had gone up so much, it pushed up the allocation to Nasdaq,” said Peng Chen, vice president in Ibbotson’s research group.
So if you didn’t rebalance and left 74 percent invested in the Nasdaq and 26 percent invested in long-term government bonds, your return in 2000 through Nov. 20 would have been a negative 18.5 percent.
The value of your portfolio would have shrunk from $150,640 to $122,712 because the Nasdaq had plummeted 28 percent while bonds had gained about 8 percent, Chen said.
On the flip side, if you rebalanced and restored your portfolio to 60 percent in the Nasdaq and 40 percent in long-term government bonds, your investments still would have lost money, but the pain would have been less severe.
In that case, the value of your investments would have fallen from $150,640 to $130,324.
“With rebalancing in a downturning market, it’s better because you have less exposure to the Nasdaq, compared with the non-rebalancing scenario,” Chen said.
Here’s how to analyze your portfolio:
“First, make sure your portfolio represents a balance of cash, fixed-income and stocks,” said brokerage Edward Jones & Co. in St. Louis.
“Next, look at the industries represented by the companies you own.”
They should be broadly diversified to protect you from overexposure to industries that are underperforming.
Investors should allocate at least 13 percent of their stock portfolios to international investments, Edward Jones said.
In addition, one stock shouldn’t make up more than 5 percent of an investment portfolio, and one sector shouldn’t make up more than 30 percent of the portfolio, said Alan Skrainka, Edward Jones market analyst.
“See how your portfolio is spread among high-quality and speculative investments,” he said. “The meat and potatoes on your plate should be in the high-quality securities with a track record of performance. The speculative ones should be like the vegetables on the side of your plate. They should represent no more than 5 percent of your portfolio.”
If your portfolio is 10 percent more or less out of whack, “that’s very significant,” Chen said.
“You definitely need to do some rebalancing,” he said.
“Don’t just look at the dollar numbers. Look at the percentage allocation because the allocation tells you what your portfolio looks like.”
But there’s really no magic number, said Dodee Crockett, first vice president at Merrill Lynch in Dallas.
“It’s a discipline that you decide for yourself,” she said. “Discipline takes out the fear and it takes out the greed — the two enemies of good portfolio management.”
You can view rebalancing another way.
“Rebalancing is a good opportunity to take your winnings and cut your losses and rethink your overall strategy,” Rhoads said. “You need to periodically make sure your allocation is based on your needs.”
The best place to start rebalancing your portfolio is in your 401(k) employee retirement savings plan or any other tax-deferred plan, experts said.
Employees who have 401(k)’s also should make sure they don’t have too much company stock in their basket to avoid overexposure.
“I don’t want to see more than a 15 percent exposure to company stock,” said J. Michael Scarborough, chief executive of The Scarborough Group Inc. in Annapolis, Md., which specializes in 401(k) education and advice.
Workers who will receive Social Security and pension benefits should treat those as bond investments that will provide steady income, he said.
Therefore, when looking at rebalancing their portfolio, those workers should lean more toward stocks because they don’t need bonds, Scarborough said.
“What they need to do is to skew that portfolio to the equity side more because the cash that they’ll receive from Social Security and their pension creates the bond-like portfolio for them,” he said.
And finally, make sure you evaluate your investments in one total picture, not as separate components.
“You have to integrate your 401(k) with your non-retirement assets,” Kemple said.
“You need to look at that in totality, not in pieces.”
