It seems you can’t watch the news or read a paper without knowing the stock market averages are hitting and surpassing all-time highs on a seemingly daily basis. It wasn’t long ago that the Dow Jones hit a low of around 6,700 in early 2009. Today, the Dow sits at around 16,000 plus. That equates to about a 140% increase in less than 5 years!
Even the NASDAQ, which saw a huge decline after the dot.com bust in the early part of the 2000’s, has hit a level of 4,000, a level it hasn’t attained since late 2000. And as a financial advisor I’m telling you that it is time to rebalance your portfolio by selling your winners and buy your losers. To which you are probably saying, “are you crazy??”

Here me out. In a rising stock market such as this year, I understand the idea of rebalancing your portfolio by partially selling investments that have grown and reinvesting in areas that have not grown as much is difficult. It is certainly harder to do if an investor has not identified specific asset allocation targets for their portfolio such as how much they should have in stocks and bonds. These types of investors are going to be more apt to let the market dictate their allocations for them.

That view is especially the case as I sit here in the last month of 2013 watching the market rise greater than 25% and the gurus are debating whether stocks are in a bubble, undervalued or overvalued, or just ready to take off to higher gains. As long term investors, we have to ignore these types of debates. These debates are generally distractions that take our minds away from more important decisions that include understanding your risk tolerance during good and not so good markets. Rebalancing your portfolio is a way of managing the fear and greed mentality that seems to rear their unpleasant heads during both good and bad markets.

The amount of exposure one has to stocks, bonds, and cash is not the same for everyone so each investor must determine their own risk profile among the asset classes they intend to use. Once that decision has been made, they’ll need to make adjustments periodically to ensure they stay within the bounds of their targets. This is called risk management.
The decision to rebalance, which would reduce areas that have gone up the most and add to areas that have not performed quite as well, is challenging these days because selling stocks to purchase bonds that have not performed well seems counterintuitive. After all, bonds may have a challenging time in the coming years as interest rates climb.

Establishing a disciplined rebalancing strategy is important to ensure your portfolio does not become more risky when stocks climb or too conservative when stocks decline.

Therefore, the following are some things to consider when thinking about rebalancing your portfolio:

• Don’t let the market dictate your overall portfolio allocation and rebalancing parameters. Your overall mix between stocks, bonds, and cash should be determined by your own goals and objectives, and not because you think the stock market is going higher or lower.

• Be aware of the types of accounts you own because it may be beneficial to make adjustments in your non-taxable accounts to help reduce realizing capital gains. You can take advantage of rebalancing opportunities in your IRAs, Roth IRAs, and employer retirement plans like a 401(k).

• You can rebalance directly back to your target allocations, which is preferably at the beginning of each year, or can rebalance maybe not all the way back to your allocations. As an example, if you set a target allocation of 10% to U.S. large value and your current allocation is 14%, then maybe you reduce it to 12% as opposed to 10%. However, my preference would be to rebalance back to your target allocations to ensure full and complete risk management.

• If you are concerned about how bonds will behave if interest rates continue rising, then you could consider allocation to cash instead. Or, you could allocate to short-term bonds and/or bond mutual funds, which have maturities less than 5 years. Bonds and/or bond funds with maturities longer than 5 years will have more interest rate sensitivity.

Wishing you a very safe and happy Holiday Season!

Every investor’s situation is unique and you should consider your investment goals, risk tolerance and time horizon before making any investment. The information has been obtained from sources considered to be reliable, but we do not guarantee that the foregoing material is accurate or complete. Investing involves risk and investors may incur a profit or a loss. Every investor’s situation is unique and you should consider your investment goals, risk tolerance and time horizon before making an investment. Please consult with your financial advisor about your individual situation.