By John Wasik
CHICAGO, April 5 (Reuters) - To some, spring means cleaning, renewal and yard work. For nervous Nellies like me who still see the ghost rider of 2008 in my rear-view mirror despite the market being up sharply so far in 2012, it means rebalancing my portfolio.
There’s nothing sexy about rebalancing. You simply plod through your account statements and reorient your nest egg toward your objectives while lowering risk. The crux is that if you do it right, you are purchasing less-favored assets and selling higher-valued securities. In other words, you are buying low and selling high, which is what most investors consistently fail to do. Far too many folks buy on the way up and hope that good times will continue indefinitely, thus ignoring the downside risk.
If you don’t rebalance, your portfolio gradually becomes dominated by higher-risk and potentially over-valued assets. When the eventual correction or crash comes along, the resulting fall is much steeper - if you haven’t rebalanced.
I took a peek at my portfolio recently, and due to the bull run of late, I noticed that stocks comprised almost 58 percent of our joint 401(k) and individual retirement account holdings. Since my wife and I resolved that we’d never let stocks comprise more than half of our portfolio, we’ll have to make some adjustments. We still haven’t completely recovered from the train wreck known as the 2008 meltdown. As you can imagine, we’re more cautious these days.
For my family’s portfolio, based on my age of 54, I like to invest at least half in fixed-income. As a rule of thumb, your age should roughly match your target fixed-income allocation, if you’re a moderate to conservative investor.
According to a study by the Vanguard Group, “if a portfolio is never rebalanced, it tends to drift from its target asset allocation as the weight of higher-return higher-risk assets increases.” (for the full study see)
In terms of reducing overall portfolio risk, Vanguard researchers found that while portfolios that were never rebalanced had an average annualized return of 9 percent from 1929 through 2009 - versus 8.5 percent for balanced portfolios-- the standard deviation (a volatility gauge) was a full 2 percentage points lower if rebalancing was done monthly. That was for a portfolio of 60 percent stocks and 40 percent bonds.
For most investors, though, rebalancing is like taking the whipped cream off a pie before you eat it. Unless you’re in automatically rebalanced target-date or age-adjusted college savings portfolios, you’ll have to make an extra effort to put it in motion.
In my own case, my wife and I will work with our mutual fund company (Vanguard), which provides a financial planner who can walk us through rebalancing as part of our service plan. We’ll have to sell some shares of our stock funds to purchase stakes in our bond-index and treasury-inflation protected securities funds.
Most larger mutual fund companies and some brokerage houses provide auto-rebalancing, although it can get complicated outside of tax-deferred retirement accounts. Most competent registered investment advisers and certified financial planners provide this service and give you big picture advice on portfolio allocations customized to your financial goals.
Do you have a 401(k) with your employer? Ask them if they provide automatic rebalancing and set it up if they do. According to David Wray, executive director of the Plan Sponsor Council of America, a group representing employer retirement plan providers, while he’s not sure how many employers provide this service, “virtually all” third parties who administer the plan platforms are set up for auto-rebalancing.
But don’t expect your co-workers to be talking up rebalancing at the water cooler. By another estimate, while more than half of employers offer auto-rebalancing, only 7 percent of employees use the service, according to Aon Hewitt, the benefits consultant, which polled employers last year.
Keep in mind that in taxable accounts, securities sales can trigger taxable capital gains. To simplify matters, you can choose to channel dividends and gains into a money-market account, where the funds can be used to buy shares during the rebalancing cycle.
You can set up your auto-rebalancing by date or asset level indicators - or both. Say you don’t want stocks to be more than 60 percent of your portfolio or you just want to do auto-rebalancing twice a year. That’s easily doable if your broker, employer or fund manager has this service.
At the very least, be honest with yourself and determine how much exposure you want to the stock market. Rebalancing may be a difficult and awkward discipline at first, but for the modest sacrifice you’d make in performance, you’ll probably be able to sleep better at night.