Keep your investments balanced

Keep your investments balanced
Daniel Jimenez • Bankrate.com

The market's ups and downs can leave an investor feeling nauseated. To help settle your stomach, evaluate your investments periodically to make sure they are still doing the job.

If the word "balance" makes you think of car tires rather than investments, now may be a good time to review your assets. Unfortunately, many investors don't have the blend of stocks, bonds and mutual funds that meet their needs. Knowing the right time to rebalance your portfolio is just as important as knowing what types of investments to carry.

Choosing the right mix

You've probably heard that you should keep a variety of investments including foreign, domestic, small-cap and large-cap stocks and funds. But what constitutes a good balance? It depends on your goals, plans and tolerance for risk.

William Green, a certified financial planner for Green/White Advisers in Houston, believes that investors should set goals in terms of at least three years so that market volatility doesn't become as large an issue. A stock market plunge can keep an investor from meeting goals if there isn't enough time for the investment to recover. That is why a person who has a one-year time horizon should place his money in conservative investments like money market accounts, certificates of deposit or government securities.

If you have a short horizon then you can't afford the volatility that can be in the market," Green says. "At least if you have a three-year horizon then it should've come back by then. The shorter your time horizon, the safer you have to be."

Investment advisers use a series of questions to determine the right mix for their clients, but their recommendations vary. For example, Gregory Fenton, a planner with Cambridge/Cape Cod Advisers in Massachusetts, thinks investors should take 90 percent of their holdings and divide them equally between interest-earning vehicles, real estate and equities, with the final 10 percent kept in cash. On the other hand, Green recommends a balanced fund that covers several asset classes for those with only a few thousand dollars to invest.

Some advisers allow their clients a small amount of "play money" to be set aside for riskier investments. But in general, the experts agree that a widely diverse portfolio provides the lowest volatility and the highest rate of return.


Time for a change

Planners take great care to develop a client's initial portfolio, but there are times when changes can be beneficial. Sameer Shah, a certified financial planner with Shah & Associates in Tampa, Fla., tells his clients that a systematic rebalancing of their assets can boost their returns by as much as 1 percent a year and lower risk at the same time.

"This can work even for a simple portfolio based on three asset classes (e.g., domestic large-cap stocks, domestic small-cap stocks, international stocks)," Shah says. "Say you start with a portfolio of 50 percent large cap, 25 percent international, and 25 percent small cap. If at the end of the year you end up with 60 percent large cap, 20 percent international, and 20 percent small cap, you should sell enough of the large cap, and buy international and small cap, so that you return to the original percentages."

Shah adds that active rebalancing is often more important in the long run than the initial actual allocation targets. Of course, this should be done, as much as possible, in tax-advantaged accounts such as a 401(k) or IRA because there are no tax consequences to moving different funds around.

There is little doubt that occasional rebalancing can be wise. But some people tend to treat their investments like a toddler who can't be left unattended for more than a few minutes. So a down market often leaves them wondering whether the baby needs tending.

If you're regularly investing on your own, rebalance the mix by shifting your purchases, rather than selling what you already have to purchase something else. For example, if the bull market has left your portfolio heavily weighed toward stocks, rebalance by purchasing more bonds. If you sell the stocks to get money to buy bonds for a quick fix, you will end up paying capital gains taxes on the stocks you sold.

Most experts caution against overreacting to market dips. Frank Armstrong III, president of Managed Account Services in Miami and chief investment strategist for directadvice.com, says investors should ignore magazine articles touting the "10 hottest funds" and focus instead on a more disciplined strategy based on sound theory.

"I don't think that investors should shuffle their portfolio more than once a year," Armstrong adds. "And that's only if one of the assets was really dropping. That would be something like 3 to 4 percent."

Shah stresses that investors must look at the portfolio's overall performance rather than focusing on one particular investment that may be faltering. Frequent changes are not recommended since individual market sectors often rebound, becoming stronger than they were before.

"I'll have a client who's got an under-performing small cap or international fund come to me and say, 'Let's dump this,'" Shah says. "That's when I explain to them, 'No, this is exactly the time when you want to stay in.'"

Cambridge's Fenton discourages major overhauls as well because of the tax consequences of selling stocks that have performed well. His firm believes that annual or biannual portfolio reviews offer an opportunity to purge bad stocks while retaining their gains.

"Every other year we sell the losers and keep the winners," Fenton says. "That is a way for us to keep making gains and not have to pay any taxes. The losses are offset by the gains."

No one can stop you from looking at your investments' progress on a monthly or even daily basis. But investors who learn not to micromanage their portfolio can rest easy as long as they are still on pace to reach their goals. Not only will they stop worrying so much about market fluctuations, but they may also find that their blood pressure will drop back to normal.


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