Question: What does BuyandHold think about rebalancing one’s portfolio?

Kim Herbmann

Answer:

Dear Kim,

BUYandHOLD does not have an official company policy about rebalancing, but of course it is something very important for investors to consider.

Some investors rebalance once a year, often in December. That’s the very minimum. You may want to rebalance twice a year. What you must avoid, however, is rebalancing every time the market makes a dramatic turn up or down. Long-term investing (or as it’s known here, buying and holding!) is a much wiser approach.

In order to effectively rebalance your portfolio, you first must know  whether you want (or already have) a high-, medium- or low-risk portfolio.

Generally speaking, a high-risk portfolio has 80% in stocks and 20% in bonds and cash. A portfolio that is low in risk would have 80% in bonds and cash and 20% in stocks. And, obviously a medium-risk portfolio would fall somewhere in between, perhaps 60% stocks and 40% bonds and cash.

If you need help in determining your asset allocation, there’s a free calculator at www.dinkytown.net. (This site, incidentally, has a wide variety of helpful financial calculators, so take time to browse about.)

Among the data that should be factored into determining your asset allocation at any one time:

• Age. The older you are, typically the more conservative your portfolio, but of course there are exceptions to this rule of thumb.

• Current assets. The more assets you have, the more protected you are, especially in a down market and thus more stocks you can reasonably own.

• Annual savings. How much you can add to your portfolio on a yearly basis will help determine how much should be in stocks.

• Tax rate. The Dinkytown calculator will ask for this figure.

• Risk tolerance. The experts who put together the Dinkytown calculator note that most people overestimate their ability to actually tolerate risk. They say that “unless you can handle a 10% decline in your portfolio during a stock market correction, you may wish to keep you risk tolerance at or below the mid-point.”

• Amount of income required. This refers to the amount you will need from your portfolio. You may not need any unless you are retired, meeting college tuition payments, paying off a mortgage or other debt, or have other financial commitments.

About market fluctuations...

Keep in mind that if a sector of the stock market takes off, then your portfolio may in turn become out of balance. For example, let’s say you had 60% in stocks, then suddenly you find that you have 80% in stocks.

When this takes place, you should rebalance which may mean selling some of your stocks or adding new money to the sector that has fallen below its target, in this case bonds and cash. This then brings your portfolio back to its original model.