How Does Your Financial IQ Measure Up?

Physician's Money Digest, May 15 2003, Volume 10, Issue 9

Physician's Money Digest

A recent survey of 750 doctorsby found that just 2% took afinancial course in college or medicalschool. In short, most busy doctorsneed help when it comes to understandingpersonal finance issues.

What'sYour Investing IQ?

To help, in thecoming months, wewill reprint sections ofthe new book (Career Press; 2003)by Carrie L. Coghill,CFP®, and Evan M.Pattak. Take a look at the followingexcerpt and see how your financialIQ measures up.

PORTFOLIO REBALANCING

How often should you rebalanceyour portfolio?

  1. At least twice a year.
  2. As market conditions dictate.
  3. Whenever your original assetallocation formula has been distorted.
  4. Any or all of the above.

The question:

Investing in multiple asset classesand sectors, with a percentage of yourportfolio assigned to each class orsector, provides you with diversificationand the chance for maximumgains with minimum risk. Alas, themarkets will pay little respect to yourcarefully crafted formula. They'll dowhat they will, wreaking havoc withyour balance. It can happen subtlyover time, or it can happen with adramatic, immediate swing in a sectoror asset class. Whenshould you step in to rebalance torestore your original allocation?

A good schedule is to review yourportfolio at least twice each year, andto rebalance it whenever your allocationformula has taken a serious hit oreconomic conditions warrant. In yourreview, compare your original assetallocation with the current status. Ifyou find only a slight variance, youmay be satisfied with doing nothing.Review in this case doesn't implyrebalance. Given that you're investingfor the long term, you may find manyyears when no changes are necessary.

Note:

Should you encounter significantvariations from your original allocation,it's time to revisit both thesoundness of the formula and currentperformance against that formula. Ifyou believe that your original allocationis sound, then you'll need to considerdivesting assets in the overweightedsectors or classes and usingthe proceeds to purchase assets inunderweighted sectors or classes—allto restore your original allocation. Don't be overly concerned withminute variations from your formula.If the figures are within, for example,2% of your original allocation, that'sprobably an acceptable tolerance.

While this sounds fairly straightforward,many investors recoil at thenotion of selling some assets withoutstanding recent performance andpurchasing laggards. This may seemcontrary to common sense, and yetinvestors in technology stocks a fewyears back probably wish they haddisplayed a little more uncommonsense by selling some of their techissues and reinvesting the proceeds inless volatile asset classes or sectors.It's very easy for last year's winners tobecome this year's losers. Remember,you created an allocation formulain part to minimize your risk. Ifyou continue to believe in your formula,stick with it and restore it, nomatter how hot or cold any 1 sectoror asset class may appear.

CHANGING TIMES

Significant market changes—bothcurrent and anticipated—also cantrigger portfolio modifications. Obviousevents to consider would bechanges in the management of anymutual funds in which you've invested.If a new manager introduces aphilosophy of frequent asset turnover,for example, that may cause you torethink your position in that fund.

A prospective shift in interest ratesalso could move you to repositionsome of your money. These actionsaren't portfolio rebalancing in theclassic sense. Rather, they're preemptivestrikes that can prevent or limitdamage to your asset allocation.

While semiannual portfolio reviewsand rebalancing as neededstrike us as a reasonable schedule,some managers of large funds gowell beyond that. They automaticallyrebalance their portfolios on a quarterlyor even monthly basis, alwaysrestoring the mix to the original allocation.If you're managing your portfolioyourself, this approach mightbe rather time-consuming. But itdoes eliminate any temptation tosuccumb to market timing. That'salways a plus.The best answer is "d,"since any of the other answers couldserve as the impetus for portfoliorebalancing. Score 4 points for "d."However, since none of the answersis incorrect, give yourself 2 points for"a," "b," or "c."

Reprinted, with the publisher's permission,from What's Your Investing IQ? (Career Press;2003) by Carrie Coghill and Evan Pattak. Allrights reserved. To order, call 800-227-3371or visit www.careerpress.com.