Investor optimism has risen a bit lately and it is easy to see why. The world’s equity markets have rallied quite dramatically since October of last year. While such positive sentiment is by no means unanimous, optimism clearly is climbing. This is hardly a surprise given such strong gains over the last few months. Of course, there is considerable debate over the staying power of this bull market. I don’t know what the future holds, but I feel now would be a good time to consider rebalancing your accounts.
The process of rebalancing forces an investor to sell high and buy low. Many people recommend rebalancing on regular intervals. Some say to do it at least annually and some as often as quarterly. I believe it is better to let the market tell you when to rebalance. I preferred to rebalance after we have seen a sustained period of either strong or weak returns in the markets. This helps keep the risk level of your portfolio consistent with your plan and avoids being overexposed to stocks before a downturn or being underexposed during an upturn. Think of the markets like you do your health. When are you most likely to catch a cold? After a sustained period of good health. When do you get better? After you have been sick a while. Markets are not much different.
Let’s take a simple example from the last few months; suppose an investor’s portfolio stood at $1,000,000 just a few months ago on October 1, 2011 and on that day the investment mix was right at their risk targeted allocation of 60% stocks (represented by the S&P 500 Index) and 40% bonds (represented by the Barclay’s Capital Aggregate Bond Index). By the end of February 2012, only five short months, the strong relative performance of stocks over bonds would have increased the stock allocation to 64% and resulted in a portfolio value of $1,132,168. That’s an over 13% gain in just five months! While it is always nice to enjoy positive returns like this in a short period of time, it is also an appropriate time to consider rebalancing. Taking profits on the stock portion and reallocating it to lower risk bonds in this example would make sense for an investor concerned with maintaining a consistent risk level in their portfolio.
Clearly, it is important to review your mix of assets from time to time. Rebalancing the mix back to an appropriate level will help an investor guard against being over or under exposed to equities at the wrong time. This is especially important at moments like now when optimism has increased and everything is beginning to feel fine.
Damien helps individuals invest and manage risk. He is a Certified Financial Planner™ professional and a principal of Walnut Creek Wealth Management. These are the views of Damien Couture, CFP® and should not be construed as investment advice. Rebalancing may be a taxable event, before taking any specific action be sure to consult with your tax professional. All information is believed to be from reliable sources; however we make no representation as to its completeness or accuracy. Not all recommendations are suitable for all investors. Each investor must consider their own goals, time horizon and risk tolerance. Your comments are welcome. Damien can be reached at 925-280-1800 x101 or Damien@WalnutCreekWealth.com.