A Rebalancing Act
By Debra Targett , Financial Consultant, CERTIFIED FINANCIAL PLANNER™ professional, A.G. Edwards, a division of Wachovia Securities, LLC
“Don’t put all your eggs in one basket.” If this everyday piece of advice comes to mind when thinking about your investments, then you may already understand the importance of a diversified portfolio. But even the most carefully composed investment portfolios can get out of balance from time to time. To make sure your portfolio stays on track to helping you reach your goals, it’s important to take the time regularly to rebalance your portfolio to make sure it’s still in line with your investment objectives.
Some of the most common reasons your portfolio could get out of balance would involve a change in the ratio of the asset classes in your portfolio, or a change in the value of your various assets. Asset classes refer to the general types of investments that make up your overall investment mix: stocks, bonds, cash, mutual funds and ETFs, to name a few. As the respective values of those various investments change, the proportions in your portfolio will change as well. That’s why it’s important to check in on your investments to make sure the division of your assets doesn’t stray too far from the allocation you want.
To help understand this problem, let’s take a look at how your portfolio can get out of balance. Consider a very basic portfolio made up of stocks, bonds and cash. Out of these three 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.
This imbalance may increase the volatility of your portfolio as a greater percentage of your assets face a higher level of risk, due to the fact that stocks tend to carry a greater 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.
Another way to look at it is to consider a hypothetical example with numbers. 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 percent on the year) while your stock holdings are now worth $11,560 (or a 15.6 percent return).
While that’s a nice overall return for your portfolio, you’ll notice that your investment mix in stocks and bonds has strayed from the even 50-50 you started with at the beginning of the year. At this point, your portfolio is 52.5 percent stocks and 47.5 percent 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.
When your portfolio gets out of balance, it’s important to realign your investments by making adjustments in accordance with your long-term strategy. Meeting with your financial consultant on a regular basis to discuss your asset allocation can help you spot significant changes and make the necessary adjustments to get your portfolio back on track.
This article provided by Debra Targett who is a financial consultant, CERTIFIED FINANCIAL PLANNER™ professional, with A.G. Edwards, a division of Wachovia Securities, LLC, Member SIPC. She may be reached at 1101 N. Congress Avenue, Boynton Beach, Fl. (561) 734 - 5054 or (800) 934 - 0543. Her Web site is: www.agedwards.com/fc/debra.targett2
A.G. Edwards generally acts as a broker-dealer, but may act as an investment advisor on designated accounts, and the firm's obligations will vary with the role it plays. When working with clients the firm generally acts as a broker-dealer unless specifically indicated in writing. To better understand the differences between brokerage and advisory services, please consult “Important Information About Your Relationship With A.G. Edwards”on agedwards.com.
