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Saturday, June 25, 2016

Balance is key to investing

Thursday, August 7, 2008

Balance is essential to almost all parts of our lives.

We balance work and family issues.

We can balance our indulgence for desserts with an extra trip to the gym.

We even balance our checkbooks.

But sometimes, we let our investment portfolios get out of balance -- and that can be a costly mistake.

Of course, for your portfolio to become unbalanced, it had to be balanced to begin with.

When you developed your investment strategy, you probably made sure your asset allocation -- the percentage of your portfolio that you invested in each asset class, such as stocks or bonds -- reflected your goals, risk tolerance and time horizon.

In short, your portfolio was balanced.

However, over time, the amount of your portfolio devoted to a certain asset class could "drift" from your initial asset allocation.

This drifting process can lead to an unbalanced portfolio -- and leave you vulnerable to market forces in ways you hadn't anticipated.

To illustrate this point, let's assume you began investing in 1982 with a portfolio weighted 50 percent in stocks and 50 percent in bonds.

But following the long run-up in stock prices, nearly 80 percent of your portfolio's value might have been in stocks by the beginning of 2000, assuming you never rebalanced your holdings.

This 80-to-20 stock-bond ratio probably was much too risky for you. As it turned out, your portfolio would have reached the 80 percent stock level at a very inopportune time -- right before the stock market decline of 2000-02.

Consequently, to help avoid taking on too much risk, you should consider rebalancing your portfolio at regular intervals to bring it back to the asset allocation that's right for your needs.

In the above example, this would have meant reducing your exposure to stocks and adding more bonds.

But rebalancing your portfolio can do more than just restore your asset allocation -- it can also help you take some of the emotions out of investing.

How?

Consider, once again, the huge rise in stock prices from 1982 to 2000.

Caught up in the euphoria of a seemingly endless bull market, many investors got greedy and kept buying more and more stocks -- including the so-called "dot-com" stocks, many of which had ambitious business plans but little, if any, actual earnings.

When the technology "bubble" burst in 2000, these stocks sank -- and so did the fortunes of their investors.

Then, during the stock market slump over the next couple of years, investors, driven by fear of more big losses, sold stocks at lower and lower prices.

The biggest sales occurred in 2003 -- right as the market was set to rebound over the next few years.

To sum up: Greed and fear caused many investors to "buy high and sell low" -- the opposite of the "golden rule" of investing.

But if these investors had systematically rebalanced their portfolios along the way, they could have helped avoid the negative results that can arise when emotions dictate investment decisions.

Even so, asset allocation does not ensure a profit or protect against loss.

Your financial advisor can help you establish a rebalancing strategy.

But don't wait too long to begin.

A balanced portfolio is an essential step toward helping you achieve your long-term financial goals.