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Giving Your Money a Checkup: Has Your Portfolio Lost Its "Balance"?

From Citi Personal Wealth Management

A few years ago, you might have been comfortable with your mix of investments. That doesn’t mean you should still be comfortable today.

The fact is, even if you haven’t made any trades and even if your appetite for risk hasn’t changed, there is a good chance your portfolio looks quite different from the investment mix you bought a few years ago. The reason: As some investments may have soared and others have slumped, you could find you have far more invested in some sectors than you intended and far less in others.

What to do? It may be time to rebalance.

Staying on target

When you first built your portfolio, you might have settled on target percentages for each market sector. Let’s assume you started with a balanced portfolio consisting of 60% stocks and 40% bonds.

The stock market then tumbles 20%, while bonds rise 5%. Not only would your overall portfolio’s value slip 10%, but also your stocks would be down to 53% of your investment mix. To rebalance your portfolio, you would need to shift money into stocks, to get back up to 60%. If stocks continue to decline, that would hurt returns. But if stocks rebound, you will likely benefit, because you now have more invested in stocks.

Most of the time, however, rebalancing between stocks and more conservative investments will tend to hold back returns. Why? You may often find yourself cutting back on stocks, which historically have generated dismal short-term results—but they have also delivered superior long-run returns.

Indeed, rebalancing should be viewed primarily as a way of managing your risk. If you didn’t rebalance during a rising stock market, you would likely find that more and more of your portfolio was invested in stocks and you could get hit especially hard when the next bear market strikes.

You might also rebalance within your stock-market investments and within your bond-market investments. Imagine that you had initially split your stock portfolio between 70% U.S. shares and 30% foreign companies. To maintain those targets, you might add to U.S. stocks when they’re suffering and trim back your foreign stocks when they have had a stretch of stronger performance.

This, again, should primarily be viewed as a way of managing risk. Still, unlike rebalancing between stocks and bonds, rebalancing within your stock portfolio and within your bond portfolio may be less likely to hurt returns—and it might help.

Take the strategy of rebalancing between U.S. and foreign stocks. If you regularly add to the sector that’s lagging and lighten up on the sector that is faring well, you might find yourself buying low and selling high. Assuming U.S. and foreign stocks generate similar long-term results, this buy low-sell high strategy may enhance your returns over the long haul—although, of course, there are no guarantees.

Bucking the trend

Be warned: While rebalancing may sound easy, it can be mighty tough in practice. You need a strong stomach to buy into depressed sectors that other investors are fleeing. That’s why it is important to think carefully about your target portfolio percentages—and whether you will be able to live with them in good times and bad.

How often should you rebalance? This is a matter of some debate. Some folks like to keep it simple, rebalancing once a year or once a quarter.

Others look to rebalance only when their investments are significantly above or below their target percentages. For instance, if you have 20% of your overall portfolio earmarked for foreign stocks, you might only rebalance if their value rises above 25% of your portfolio or falls below 15%.

Think twice before rebalancing solely into an individual stock or bond. There’s always the risk that an individual security will fall in value—and then keep on falling, possibly going to zero. Rebalancing may make more sense with diversified investments, such as mutual funds and exchange-traded index funds. Such investments may suffer big short-term losses, but they are less likely to lose all value than an individual stock or bond.

As you contemplate tweaking your portfolio, also give some thought to trading costs, which will eat into any gain from rebalancing. If your investment trading costs are high, you may want to rebalance less frequently.

Taxes are another cost you may want to consider. While rebalancing within a retirement account – shifting from one investment to another – doesn't trigger any immediate taxes, selling in a taxable account could unleash a big tax bill. Indeed, if you need to rebalance within your taxable account, you may want to try to avoid selling investments with big capital gains.

Instead, to get your portfolio back into balance, you might direct any dividends, interest and new savings into those sectors that have fallen below your target percentages. And if you do have to realize capital gains, you might try to offset those capital gains by taking capital losses in other parts of your portfolio.

 

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The information provided here is solely for informational purposes. It is not an offer to buy or sell any of the securities, insurance products, investments, or other products named.

Diversification and asset allocation do not protect against loss and does not guarantee a profit.

There is no guarantee that these strategies will succeed. The strategies do not necessarily represent the experience of other clients, nor do they indicate future performance. Investment results may vary. The investment strategies presented are not appropriate for every investor. Individual clients should review with their Financial Advisors the terms and conditions and risks involved with specific products or services. Past performance is no guarantee of future results.

Investments are subject to market risk and may fluctuate in value. The investment strategies presented are not appropriate for every investor. Each investor should review with their Financial Advisors the terms, conditions and risks involved with specific strategies.

There may be additional risks associated with international investing, including foreign, economic, political, monetary and/or legal factors, changing currency exchange rates, foreign taxes, and differences in financial and accounting standards. These risks may be magnified in emerging markets. International investing may not be for everyone.

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