- The Washington Times - Monday, November 30, 2009

Q Should we be rebalancing our retirement investments? With the financial turmoil, making changes has me scared of doing something wrong. Also, how often should we rebalance?

A: Suppose you have $100,000 invested for your retirement in an asset allocation of 60 percent stocks and 40 percent bonds. And further suppose that during the next two years, stocks drop 50 percent in value while your bonds produce a total return of 10 percent. Here’s what will happen to your asset allocation in the absence of any changes from you. Starting mix: stocks $60,000/bonds $40,000; mix after two years: stocks $30,000/bonds $44,000.

So, after two years, instead of having 60 percent in stocks and 40 percent in bonds, you have about 41 percent in stocks and about 59 percent in bonds. To return to your original chosen allocation, you would need to move about $14,400 out of bonds and into stocks. Making such a change is called rebalancing.

Starting mix: stocks $60,000/bonds $40,000; mix after two years: stocks $30,000/bonds $44,000; mix after rebalancing: stocks $44,400/bonds $29,600.

Now, most sane and sensible people might ask why you would take money from an investment that is doing well (bonds) and put some of that into an investment that is doing poorly (stocks). The reasons are first to get your investment plan back on track and second to take advantage of the inevitable rebound stocks should enjoy eventually.

Rebalancing is a rather clever system that disciplines you to buy low and sell high. Here are some important tips to make the most of and be smart about rebalancing: Beware of tax consequences. If you’re selling investments outside retirement accounts and those sales trigger realized profits, you will owe tax on those profits. That’s why rebalancing is best done with money inside retirement accounts, where you needn’t be concerned with tax consequences on transactions.

Beware of transaction costs. This isn’t an issue with most no-load mutual funds and exchange-trade funds, but it will cost you to trade most other investments. That doesn’t mean you shouldn’t rebalance if you will pay some transaction costs. It does mean that you should fully understand trading fees before you take action.

Find ways to rebalance by not making unnecessary trades. You can avoid transaction and tax costs by rebalancing with distributed investment income (interest and dividends), new contributions and planned withdrawals.

Select a sensible rebalancing period/trigger. Numerous studies have shown that the benefits don’t outweigh the costs when rebalancing is done frequently, such as monthly and quarterly. Those studies and my experience suggest that the best approach is to review your portfolio at least one to two times per year and rebalance if your investment allocations have moved off base by at least 5 percent. So, for example, if you have 60 percent in stocks and 40 percent in bonds, if the stock allocation gets to 55 percent or 65 percent, or the bond allocation gets to 35 percent or 45 percent, you should rebalance.


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