Personal Finance: Rebalancing portfolio deals with market shifts

Personal Finance: Rebalancing portfolio deals with market shifts

February 22nd, 2012 by Chris Hopkins in Business Diary

Perhaps the most important aspect of an effective investment plan is the asset allocation. Deciding upon an appropriate mix of equities, fixed income and cash is essential to long-term success as an investor.

One oft-neglected but essential component of keeping the right mix is the need to periodically review and rebalance the portfolio to maintain the target allocation over time.

A well-considered asset allocation depends upon a number of factors, including age, employment status, risk tolerance and specific goals like cash flow and legacy planning. The plan is likely to include some specific percentage allocations to U.S. equities, foreign stocks, bonds, commodities such as gold and silver, and some cash equivalents.

However, over time some classes perform better than others, leading to gradual deviations from the original target mix. This development requires that investors periodically shift funds from some asset classes into others to restore the desired balance.

Gone are the days when a portfolio can be left on autopilot. The old buy-and-hold strategy has not worked over the past decade and is unlikely to prevail over the next.

It is essential that investors monitor and rebalance at least once a year to adapt to variegated sector returns and keep on track to achieving their ultimate goal. Early in the year is a good time to revisit the plan and freshen up the mix.

Generally, asset class returns do not move in lockstep but ebb and flow in an endless rotation from year to year. This year's best performer often sinks to the middle of the pack the following year. Of course this lack of synchronicity or correlation is the precise reason for diversifying among asset classes in the first place.

However, to make the strategy work one must periodically restore the target mix following bouts of uneven performance.

The importance of periodic realignment was amply illustrated over the past two years. While U.S. equities made small gains in 2011, emerging market stocks plummeted 21 percent, leaving a big hole in investors' portfolios.

But that big dip was coming off of a very respectable 16 percent gain in 2010, so the investor that rebalanced early last year had taken some profits and had less exposure to the steep decline.

Now, if the same investor had again rebalanced at the beginning of 2012, he would have snapped up emerging market stocks at a discount, just in time to benefit from the 16 percent run-up so far this year.

The point is even more sharply illustrated with U.S. Treasury bonds. To the surprise of most analysts, long-term U.S. government bonds were the best performing investments in 2011, jumping 29 percent and resulting in a serious overweight condition in a balanced portfolio. Rebalancing early in 2012 turned out to be just the ticket, as bonds are down 4 percent so far this year.

Step one is creating a thoughtful investment plan and asset allocation. But it is also critical to review and rebalance your portfolio at least once a year to keep the plan effective.

Get answers to financial questions on Wednesdays from our columnists who work in the financial services industry. Christopher A. Hopkins CFA, is a vice president at Barnett & Co. Submit questions to his attention by writing to Business Editor Dave Flessner, Chattanooga Times Free Press, P.O. Box 1447, Chattanooga, TN 37401-1447, or by emailing him at