A Rebalancing Act

Financial experts generally advise investors to allocate their assets between stocks and bonds and to rebalance those assets at least once per year to keep to that allocation matrix. That may be sound advice, but some not-so-diligent investors are more inclined to "set it and forget it" than to take time to rebalance their portfolio. If pressed, they may claim that market forces will do the job for them automatically.

Financial experts generally advise investors to allocate their assets between stocks and bonds and to rebalance those assets at least once per year to keep to that allocation matrix. That may be sound advice, but some not-so-diligent investors are more inclined to “set it and forget it” than to take time to rebalance their portfolio. If pressed, they may claim that market forces will do the job for them automatically.

Market forces can indeed do a job on your portfolio. During the dot.com meltdown, stocks lost more than a third of their value while bonds went up by more than a third. Surprisingly, even though stocks have been beaten up over the past year or so, they’ve gained more than 60% since the start of 2003, while bonds have gone up by just 20%. After these ups and downs, your asset allocation may be just as you set it up. What does it matter if it isn’t?

It matters because asset allocation is really a way of showing how much risk you’re willing to take on for a given return. For example, a stock-heavy portfolio is traditionally seen as riskier, but offers a chance for higher yields. So unless your tolerance for risk has changed, your asset allocation shouldn’t change either. Adding to the case for rebalancing is the fact that, left alone, your portfolio can become top-heavy with either stocks or bonds, leaving you vulnerable to downdrafts in the overweight portion of your portfolio and shorting the assets that may be due for a run-up.