Be Diligent in Your Asset Rebalancing Act

Physician's Money Digest, July 2007, Volume 14, Issue 7

The most common reason portfolios get out of balance is a change in the value of its various assets. These changes in value alter the ratio of asset classes. Asset classes refer to the types of investments that make up your overall investment mix: stocks, bonds, cash, and mutual funds, to name a few. As the respective values of those various investments change, the proportions in your portfolio will change. That's why it's important to check that the division of your assets doesn't stray too far from the allocation you want.

A basic portfolio is made up of stocks, bonds, and cash. Of these asset classes, stocks are likely to see the biggest price fluctuations. If the price of your stock position rises significantly, the overall percentage of stocks in your portfolio grows in relation to the percentage of cash and bonds. The proportion of cash and bonds is, therefore, decreasing.

Imbalance Can Increase Risk

This imbalance may increase the volatility of your portfolio as a greater percentage of your assets face a higher level of risk. At the other end of the spectrum, if your stock prices drop, the percentage of equity assets in your portfolio decreases as well. The risk is lowered, but so is your opportunity for growth.

Let's say you invest $10,000 in bonds and $10,000 in stocks at the beginning of the year. By year end, you see that your stake in bonds has grown to $10,475 (for a return of 4.75% on the year) while your stock holdings are now worth $11,560 (or a 15.6% return).

Facing the Consequences

While that's a nice return, you'll notice that your investment mix in stocks and bonds has strayed from the beginning even balance of 50% stocks and 50% bond. At this point, your portfolio is 52.5% stocks and 47.5% bonds, and at this pace, the difference could get much bigger in just a few more years. Rebalancing helps put you back in line with your original allocation.

It's important to realign your investments by making adjustments in accordance with your long-term strategy. Meeting with your financial consultant regularly to discuss your asset allocation can help you make the adjustments to get your portfolio back on track.

The Bottom Line

  • Changes in the value of assets can change a portfolio's allocation percentages.

Unbalanced portfolios can increase risk and decrease growth.

  • Meet with your financial consultant on a regular basis to check the balance of your portfolio.

Joseph F. Lagowski is vice president, investments, and a financial consultant with AG Edwards in Hillsborough, New Jersey. He welcomes questions or comments at 800-288- 0901, or visit www.agedwards.com. This article was provided by AG Edwards & Sons, Inc, member SIPC.