SAN FRANCISCO – Holiday cheer also brings investors holiday chores.
Tax-related stock selling, charitable contributions, retirement-plan decisions and other record-keeping requirements loom large as the year draws to a close. Yet in the shuffle of paperwork, one crucial investment decision is often overlooked.
Rebalancing, the periodic buying and selling of stocks and bonds to restore an investment portfolio's original settings, is a New Year's resolution that's easy to break. After all, committing to sell winners and use the proceeds to buy laggards not only seems unnatural, but downright painful.
"It's always going to feel bad," said Harold Evensky, a financial adviser with investment firm Evensky & Katz in Coral Gables, Fla. "You take a lot of profits off the table and buy cheaply things that stand to recover. That's what everyone says they want to do — sell high and buy low. But it feels terrible."
Terrible, perhaps, but it's a move that can deliver long-term benefits. Over time, regularly rebalancing portfolios to preset asset allocations keeps investment objectives on an even keel, reducing risk substantially without forfeiting much return.
Waiting to rebalance and clinging to the past can be costly. Letting winners ride is a form of market-timing, a bet that leaves your portfolio vulnerable to downturns in top-performing investments.
"The problem is that the rebalancing never gets done, and when areas that have done well go the other direction — often as part of the normal cycle — you didn't capture the gains," said Scott Kays, president of Atlanta-based wealth manager Kays Financial Advisory Corp.
Tipping the scale
Rebalancing a portfolio annually, at the beginning of the year, is a sensible strategy. What to rebalance, and how much, depends on how the prior year's market environment has affected your asset allocation.
Like location is to real estate, asset allocation is the prime factor in whether or not you achieve investment success, most financial experts believe. A recent survey of investment professionals conducted by mutual-fund firm AllianceBernstein reported that 83% of financial advisers said that proper asset allocation could have cut investor losses by at least half during the 2000-2001 market correction.
Rebalancing doesn't have to be complicated. Suppose you've earmarked 40% of a portfolio to U.S. stock mutual funds, 20% to international stock funds, and 40% to bond and money-market funds. International stocks have posted double-digit gains this year and U.S. stocks are up modestly, while bond returns have been lackluster.
Most likely, the value of the stock portion of the portfolio has increased and the bond allocation has slipped. To restore that original 60-40 balance between stocks and fixed-income, you'd have to sell cherished stocks and buy underloved bonds.
"You have to take the emotion out," Evensky said. His policy is to keep clients' stock and bond weighting within an 8% band, so if a 50-50 stock and bond mix changes to 58-42, the better-performing asset is sold to make room for the category that hasn't done as well.
"We don't think about it; we just do it," Evensky added.
Many investors are following that advice, handing the portfolio-rebalancing job to so-called target-retirement funds. These specialized funds automatically allocate between stocks and bonds over time, making them ideal for 401(k) and other retirement plans. But they're not set-it and forget-it decisions.
More experienced, do-it-yourself investors should fine-tune portfolios to reflect changes in specific styles and sectors.
For instance, small-capitalization U.S. stock funds have surpassed their larger counterparts for several years — until this year — leaving unbalanced portfolios underexposed to large caps. Appropriately rebalancing would trim small-cap holdings and increase large-cap positions, as many investment professionals now advise.
Rebalancing is especially crucial when high-octane sectors supercharge a portfolio. Consider two of the year's best fund investments: natural resources, soaring 36% through Tuesday, and diversified emerging markets, rising 31%, according to investment researcher Morningstar Inc.
Given such outstanding gains, it's prudent to lighten up on natural-resources and emerging-markets funds — at least to earlier percentage weightings — and possibly to add stakes in the year's lesser lights such as financials, health care and technology.
"Rebalancing has to be a religion," said Marc Mayer, chairman of AllianceBernstein, a unit of Alliance Capital Management Holding L.P. "You have to systematically buy low and sell high. When you feel it's least right is when you have to embrace it the most. That's the way great money management is done."