A savvy long-term investor often views market corrections with anticipation, especially if that investor has enough liquid cash on hand to accumulate stocks at bargain-basement prices. The problem with this strategy is that the investor often forgets to balance that portfolio in preparation for the next correction. Since there's been a substantial rise in the markets over the past year, some pundits suggest that markets might be ready for a downturn. Even if the doomsayers are incorrect and the markets continue to climb, is your portfolio balanced and diversified?

Over the past few weeks I've taken some advice into consideration and took a few actions to balance my holdings. Not only do I feel comfortable that I'm not vested solely in one sector or mainly in large caps as opposed to small caps, I began to see my investments in a whole new light - I've finally detached my emotions from my stocks (after seven years!) and have actually developed a personal investment strategy.

I find it ironic that it's taken seven years to develop this healthy dose of caution and reason. Perhaps that time frame is significant, since the last major correction in the markets occurred about seven years ago. But the recent rise in the market doesn't seem to be accompanied by the same irrational behaviors that qualified the tech sector in the late 1990s.

That end-of-century enthusiasm, which pushed some tech stocks to $100 increases per share overnight in the late '90s, doesn't exist today. Maybe that's why I didn't encounter any brick walls when I went on a search for guidelines to diversification and portfolio rebalancing. It seems that seven years isn't long enough for some folks to forget how much money can be lost within a month when a portfolio is sector-heavy.

Some of the tips that I found and followed in the process of balancing and diversifying my holdings are as follows:

1. First, I needed to define my investor role as "long-term" rather than "short-term." Since I like to find tax shelters and deductions in any nook and cranny, I try to hold onto my stocks more than one year and one day, as the tax advantages [PDF] work in my favor. The ability to lower my taxes helps me to avoid the day trading syndrome that seems ingrained in my veins.
   
   
2. One tip stated that if any one stock constitutes more than 20 percent of the value of a portfolio's holdings, then this imbalance could increase risk. This increased value can be due to overbuying, or the stock may simply have done well over the past year. Either way, that imbalance could be corrected with a reduction in that stock or increased purchases in other holdings. If I haven't held the stock more than a year, then I can't sell it (according to my rules), so I need to have enough liquid cash on hand to increase my other holdings. The fact that I need this liquidity has forced me to save money in a liquid interest bearing account.
   
   
3. On the other hand, if I own a stock that takes up five percent or less of my portfolio, then this stock is taking up my time and money. That balance seems disproportionate, so I need to accumulate more of that stock or sell it.
   
   
4. My worst habit is to try to time the market for sales and purchases. According to Sam Stovall, an investment strategist for Standard & Poor's and a columnist for Business Week Online, even if stocks are purchased at the high end and a correction occurs, it normally takes only three years on average to see a new high. One exception to this theory includes certain tech stocks that enjoyed irrational highs in the late 1990s. Instead of timing the market, I need to be consistent about my accumulations.
   
   
5. First, for sector diversification, I was advised to think about following the most popular sectors with the current S&P "top ten" makeup. Currently, if I followed this trend, I would need to think about pursuing rail and trucking (transportation/services), healthcare, biotech, agricultural chemicals, construction (industrial and residential), and NASCAR. When I compared the sectors in the S&P top ten to the sectors listed at BUYandHOLD, I realized that this top ten group has neglected over half the sectors on that list. This omission is a reason to wonder why tech, food and beverage, and energy and utilities weren't included in that S&P top ten. Accordingly, I wondered why I was holding consumer goods rather than biotech?.more reason for research.
   
   
6. The S&P top ten also ranges from small- to large-cap stocks. While I love the 'passive investment' factor involved with receiving and/or reinvesting dividends, I also need to think about diverting some of those investments into small- and mid-sized cap stocks. On the other hand, if you live for the risk involved with small-cap stocks, you might want to invest in some large-cap stability to help balance that portfolio.

One way to balance sectors and company size in your portfolio is to rely on that same 20 percent and five percent evaluation used for the holdings in your portfolio. For instance, if one sector comprises more than twenty percent of your holdings, then either reduce those holdings or beef up your other holdings in other sectors to balance them out. If large caps comprise less than five percent of your portfolio, you might consider increasing your holdings in large-cap stocks to balance your risk.

Also consider that the S&P top ten changes over time, which is a great indicator for your own holdings. A stagnant portfolio is similar to a pair of old shoes. After a year or so of constant usage, something's gotta give. Either the shoes will fail you or you can gain control by fixing them or by sending them out the door - and not on your feet. The same theory goes for the stocks in your portfolio - fix them or say goodbye. When the next correction rolls around, you can smile like a Jimmy Buffet wanna-be as you savor the value of your long-term investments.

Until Next Week,
Linda Goin