Throughout its history, the investment market obviously has experienced volatile years, going in both positive and negative directions. Such dramatic swings in stock returns typically provide invaluable lessons — and also raise a question all investors should answer every year: Do I need to rebalance my portfolio?
Rebalancing a portfolio involves periodically readjusting its mix of assets. Smart investors start by establishing an initial asset allocation, assigning percentages of the portfolio to assets such as stocks, bonds and cash and perhaps other types of investments, such as real estate and commodities. The allocations are further broken down by subcategories, such as different types of stocks and bonds.
The target allocations should be appropriate for that investor’s investment goals and financial circumstances as well as comfort level with certain types of investments. Investors also may readjust target allocations to reflect major changes in their personal financial circumstances.
Why rebalance just because a portfolio no longer matches its original allocation? Why not just let it ride — especially if the market’s going up? If you don’t, you increase the risk that you may not achieve your investment goals.
Let’s put it into perspective. Consider your portfolio in a market scenario in which a mix of stocks across various asset classes, sectors and markets (large-cap, technology and international, for example) collectively bring about strong returns. Meanwhile, much of the bond market suffers a significant setback. What impact would these major market changes have on your portfolio? Would they alter your original asset allocation? How much would they alter the mix, and should some of the investments be balanced?
How much to allow a specific asset category to shift before readjustment is up to you, but a common guideline is 5 percent. To rebalance, consider directing future investment funds into those underrepresented categories until it is back in balance. You can also readjust by selling off some of the overrepresented assets (the winners) and buying the underrepresented (the losers) — selling high and buying low. It is usually better to execute this strategy within tax-favored accounts to avoid taxes on gains, but if you need to rebalance taxable accounts, don’t let tax concerns necessarily derail you.
Contact your financial advisor for more information about rebalancing you portfolio — it could take some weight off of your mind.
Investors should consider the investment objectives, risks, charges and expenses of a fund carefully before investing. For a prospectus containing this and other information for the mutual funds offered, call your financial advisor. Please read the prospectus carefully before investing.
Please note that mutual funds will fluctuate in value, and an investor can lose money by investing in mutual funds.
Information provided by Ryan Weidner, Waddell & Reed Financial Advisor, 4201 Westown Parkway, Suite 330 West Des Moines, 515-278-2347.