Rebalancing Your Portfolio on a Regular Basis

Does your portfolio need to be rebalanced? Do you have too much stock and not enough bonds? Too much cash and not enough stocks? Is too much of your stock portfolio in technology?

Most portfolios are composed of a mixture of stocks, bonds, and cash equivalents. Stocks offer growth potential, bonds offer income, and cash provides liquidity. Your asset allocations will depend on your investment time horizon and your attitude towards risk. The longer the time horizon and the higher your tolerance for risk, the greater your recommended exposure to stocks. But asset allocation is an ongoing process.

Let's imagine that at the beginning of 1999, you decided you wanted to hold 60 percent of your portfolio in stocks, 35 percent in bonds, and 5 percent in cash equivalents. Because of the run-up in stocks during the year, you may have ended 1999 with 75 percent or more of your portfolio in stocks. This occurs because assets appreciate or depreciate at different rates. Even if you don't move money from one class to another, your percentages will change with the flow of the market.

Most financial planners advise their clients to go through their portfolios occasionally and make sure the weightings for each asset class still make sense.

"You should consider rebalancing when you're five percentage points away from your target allocation," says Tom Biwer, an investment analyst with Wells Fargo Advantage Funds.®

"If someone had a 50/50 stock/bond allocation and now it is 60/40 simply because they had so much growth, then that's an instance where we rebalance the portfolio." This was common during the 1990s, when stocks dramatically outperformed bonds. Biwer says such a shift is a good opportunity to see if a client's objectives have also changed.

"If they decide that their long-term investment objectives have changed because they're getting closer to retirement, then we would rebalance in that fashion," he says. "If they had other expenses coming up, such as college tuition, then we would rebalance for that."

Rebalancing among various sectors of the stock market is also an important consideration, because certain types of stocks come in and out of fashion. You may decide you want to divide the equities in your retirement account between large growth stocks, large value stocks, small-cap stocks, and international stocks. It's likely that by the end of the year, your portfolio will look very different than it did at the beginning.

Once you've made the decision to rebalance, then some tough choices have to be made. If you're rebalancing between stocks and bonds, you could sell some of your stocks and use the money to buy bonds. You could also bring the portfolio back into balance simply by buying more bonds. If, during 2000, you became underweighted in stocks because of the market downturn, you could add stocks to your portfolio.

When rebalancing your taxable account, there are special considerations. You might have some big winners in the portfolio that will generate capital gains taxes when sold. And you might not want to part with these securities because they have performed so well. One alternative is to sell a part of the position and use the proceeds to bring your portfolio back into balance. That way you still have a position in your favorite stocks.

Stock funds should only be considered for long-term goals as values fluctuate in response to the activities of individual companies and general market and economic conditions. Bond fund values fluctuate in response to the financial condition of individual issuers, general market and economic conditions, and changes in interest rates. In general, when interest rates rise, bond fund values fall and investors may lose principal value. Some funds, including non-diversified funds and funds investing in international securities, high yield bonds, small- and mid-cap stocks and/or more volatile segments of the economy, entail additional risk and may not be appropriate for all investors. Consult a Fund's prospectus for additional information on these and other risks.

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