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 A 60 percent stocks-40 percent bonds portfolio will get out of
kilter if you leave it alone long enough. To rebalance, you have to
cut back on the portion that grew - typically the stocks - and add
money to the other side.
An investor who does that regularly will protect herself from taking
more risk than she intends. She also will often lock in gains and
buy securities at better prices than she might otherwise.
Last year - a boom year for stocks and a bad one for bonds -
provides a classic example of why investors need to rebalance.
If you started 2013 with a $100,000 portfolio invested in two funds
- one 60 percent invested in Standard & Poor's 500 stock index and
40 percent in Barclay's Global Aggregate Bond Index, via exchange
traded funds, you would have ended the year with a much more
aggressive stance: 68 percent stocks and 32 percent bonds.
Rebalancing is easy for workers who invest through their company
401(k) plan. A one-fund program, such as a target date retirement
fund, will be regularly and automatically rebalanced by its
managers. Large company retirement plans often let workers leave
standing automatic rebalancing orders, so their portfolios can be
adjusted quarterly or annually.
That works especially well for retirement investors because there
are no tax consequences to their rebalancing efforts.
But individual investors who have non-retirement portfolios of their
own have to work harder to make rebalancing work. That's because
their trades often involve some transaction costs and some tax
consequences. And because they may have to rebalance manually,
instead of on autopilot.
Here's how to do it best.
DON'T JUST STICK WITH THE CALENDAR
This year tells a different story. With the S&P 500 up 4.43 percent
and the bond index up 5.51 percent, asset allocations haven't
changed much. Instead of regularly rebalancing even small amounts,
let the growth of your investments be your guide, suggests Ben
Welch, director of advisor business development at TD Ameritrade
Institutional.
Welch's firm has software that allow its advisers to monitor
portfolios by their asset allocation, but individual investors can
watch the same numbers.
Set a band of 5 percent or 10 percent, and when one part of your
portfolio outgrows its intended allocation by that much, start to
think about rebalancing. For example, think 'rebalance' once a 60
percent stock portfolio turns into a 66 percent stock portfolio.
Will you miss the top of the market with part of your investments?
Yes, but you'll take solid earnings off the table.
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CONSIDER COSTS
If you have to rebalance via a brokerage account that has high
transaction fees, rebalance less often. That was the conclusion of a
paper published recently in the Journal of Portfolio Management.
Bank of America's Merrill Lynch researcher Himanshu Almadi and
others said investors facing low costs would do better rebalancing
quarterly, those facing higher costs should rebalance once a year.
PLAN FOR TAX CONSEQUENCES
It's better to hold taxable securities for at least a full year so
they can qualify for lower long-term capital gains tax rates.
You can cut your taxes further by selling your losing investments
while you're selling your winners, to lock in those losses. You can
rebuy the same losing investment in 31 days, or simply buy a similar
but different one immediately to complete the rebalancing.
Brian Burmeister, a Denver financial adviser with Charles Schwab's
private client group, tells his clients to sell losers before they
hit the long-term one-year mark.
That way, at tax time they can offset short-term gains and ordinary
income, both of which are taxed at higher rates than long-term
gains.
THINK OUTSIDE BROAD CATEGORIES
Don't just think of stocks and bonds. Rebalance a global portfolio
when one region runs away from the others. Rebalance a mixed stock
portfolio when growth stocks get away from dividend-producers.
Do this steadily enough and you might turn into one of those rare
finds: an individual investor who buys low and sells high.
(Editing by Bernadette Baum)
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