Rebalance Your Investments to Keep Them on the Right Track

(This article was originally published in the April 2010 issue of Hark.)

If you make your own investment decisions, you probably know how important it is to choose the most appropriate asset allocation, or investment mix. However, it is equally important to periodically review your portfolio and rebalance it, if necessary, to preserve your intended asset allocation.

What Is Rebalancing?

Rebalancing is moving account balances among your investments so they match your original target asset allocation. Different assets produce different investment results, so, over time, your portfolio may drift away from your original allocation. This can occur even if you don’t make any withdrawals or transfers between investments. Before too long, assets with better performance will comprise a larger-than-intended proportion of your account, while assets with less robust performance will make up a smaller-than-intended segment. When this happens, it’s time to rebalance.

Consider This Example*

Suppose a participant in a General Board-administered retirement plan with a $100,000 account balance selects the following asset allocation:

• 18% Stable Value Fund ($18,000),
• 22% Domestic Bond Fund ($22,000),
• 20% Inflation Protection Fund ($20,000),
• 21% Domestic Stock Fund ($21,000), and
• 19% International Stock Fund ($19,000) allocation.

Now, suppose the equity markets rise, which increases the value of the stock funds. At the same time, let’s assume the fixed-income markets have not kept pace with equity markets. This sample participant has continued contributing regularly to her portfolio, and she invests each new dollar according to her original asset allocation. Is this enough to preserve her target investment mix? Not quite. Her portfolio might look something like this after the hypothetical market changes:

As you can see, this participant’s original asset allocation is no longer intact. For example, she now has a lot more stock than she originally intended. How would rebalancing remedy this? Rebalancing is, in essence, following the time-tested “buy low and sell high” investment strategy. Rebalancing would involve selling some Domestic Stock Fund and International Stock Fund units and buying some Stable Value Fund, Domestic Bond Fund and Inflation Protection Fund units. This would restore her original asset allocation. Here is how her rebalanced portfolio would look:

Rebalancing Can Minimize Risk

Rebalancing may seem counterintuitive, at first glance. It might involve selling investments that have recently performed well and buying investments that have produced relatively weaker returns during the same time period. However, rebalancing allows you to “buy low and sell high” without resorting to market timing, a risky strategy that rarely succeeds. Think of rebalancing as a way to manage risk over the long term, rather than a means of maximizing short-term returns. In fact, research shows that rebalancing generally both lowers overall risk and increases long-term returns.

How Often Should You Rebalance?

The most common approach is to review investments and rebalance them, if necessary, at regular intervals. Many investors check their portfolio every quarter after receiving their account statement. They may rebalance if their asset allocation has changed significantly (for example, if their allocation to stock has increased or decreased by 5%). At the very least, it’s a good idea to review your portfolio once a year.

LifeStage Provides Built-In Rebalancing

Don’t want to take the time to rebalance? Let the LifeStage Investment Management Service (LifeStage) do it for you! This no-cost service allocates participants’ contributions and those made by their employer or salary-paying unit among five of the General Board’s funds. LifeStage determines a target asset allocation for each participant (based on his or her General Board-administered retirement plan balance(s) and responses to the LifeStage Personal Investment Profile) and automatically rebalances his or her portfolio periodically to preserve this allocation. For more information about LifeStage, visit www.gbophb.org/sri_funds/lifestage.asp or call the General Board at 1-800-851-2201 from 8:00 a.m. to 6:00 p.m., Central time, Monday through Friday.

* This example is presented to illustrate the importance of rebalancing and is not meant to be indicative of the actual performance of General Board-administered funds or the financial markets. In addition, the portfolio allocation in the example is for illustrative purposes only and is not intended to be a recommendation for a particular allocation.