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Dave Patterson and Erin Preston, a father-daughter team of Certified Financial Planner® licensees, provide thoughts and suggestions on a broad collection of personal finance topics.  Information provided in this BLOG is intended to be of a general nature and may not be appropriate for all situations.  Readers should consult with their own financial advisors before relying on any information contained herein.

Thursday, August 27, 2009

Time for a Portfolio Rebalance?

Last Friday, the Dow Jones Industrial Average ended up 155.91 points at 9505.96, for a yearly high. Many investors may be tempted to move more money into large domestic U.S. stocks to avoid missing out on the current rally. Unfortunately, this may be exactly the wrong thing for them to do!

We help our clients select a target portfolio that consists of nine distinct “asset classes”. They include: cash or cash equivalents, short-term bonds, intermediate high-quality bonds, international bonds, high-yield bonds, large domestic stocks, small domestic stocks, international stocks and real estate equities (via REITs). For all asset classes, we recommend low-cost, no-load mutual funds. Each asset class has a target percentage for that part of the portfolio.

Once our clients achieve their target portfolio, we recommend they rebalance it at least once a year. Rebalancing involves bringing each asset class back to its target percentage. That involves selling those assets that are over-allocated and buying those that are under-allocated. This forces our clients to buy low and sell high, versus the “typical” investor who buys high during market rallies and sells low in market crashes.

If we assume that you have selected a target portfolio consistent with your risk tolerance and periodically rebalance it, it is likely that you now have a larger percentage of equities (including U.S. domestic stocks) than you previously targeted. If you add more, now, you will be taking on more risk in your portfolio than you originally were comfortable with. Instead of buying more large domestic stocks, you should sell some and reinvest the proceeds in the other under-allocated asset classes.

If you worry that the current rally will continue and you will miss out, keep in mind that you will still have a significant position in U.S. large stocks, which is consistent with your desired level of risk. If the market continues its rally, you’ll benefit. If the economic recovery slows and U.S. stock prices take a dip, the impact will be reduced by the fact that you moved some of your money to other asset classes.

A disciplined investment strategy that includes periodic rebalancing can help you avoid letting your emotions drive your investment decisions. Buying into a rally may not be the best thing to do.


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