If you are conscientious enough to design and track an investment portfolio, you should certainly have cause to rethink it at some point. You may be entering a new phase of life that requires a new investment horizon. Perhaps unexpected changes in your family or financial circumstances call for different strategies. Whatever the reason, it may be necessary, or appropriate, to make some changes to the composition of your portfolio.
You can change your portfolio through one of two basic strategies: redesigning or rebalancing. Redesigning, the more drastic of the two measures, involves dismantling your old portfolio and starting fresh with a new one. Redesigning your portfolio might be a viable option for you in extreme cases. An example is every part of your portfolio has failed to meet your expectations. You should, generally, not choose this strategy based solely on investment performance.
When faced with a major life change, such as retirement, you should definitely consider redesigning. If you are about to retire and have not made much change your portfolio in 30 years, it may be time for a complete overhaul. Your investment needs and goals change over that time. In such a case, the redesigning process might involve eliminating investment categories that may no longer be appropriate, while adding fixed-income bonds and/or other investments that better suit your current needs.
You should not be too quick to totally redesign your portfolio, however. For example, while loss of a job certainly qualifies as a major life change, it does not necessarily mean that you should redesign. If you are panic-stricken over the sudden loss of income, keep in mind that it may only be temporary. You may find a new job that restores your financial security and supports the investment goals on which your original portfolio was built.
Rebalancing involves restoring your original asset allocation by shifting your funds among investment categories to regain the ratios you decided on when you first designed your portfolio. You make changes, as needed, to bring your asset allocation in line with the plan originally determined to be appropriate for your investment objectives.
Example(s): Your original asset allocation scheme calls for 50 percent stocks, 30 percent bonds, and 20 percent cash alternatives. You have $100,000, so you begin with $50,000 in stocks, $30,000 in bonds, and $20,000 in cash alternatives at the beginning of the year. Over the course of the year, your stocks provide a 10 percent return, bonds a 5 percent return, and cash investments a 1 percent return. Consequently, assuming that you reinvested your earnings, at the end of the year you have $55,000 in stocks, $31,500 in bonds, and $20,200 in cash. This means that the distribution of your assets has changed to 52 percent stocks, 30 percent bonds, and 18 percent cash.
This example is for illustrative purposes only, and does not represent the actual returns of any investment or portfolio.
This change in percentages may pose a problem, because you chose the original percentages, with the intention of maintaining them in accordance with your own particular risk tolerance and expected return. Since stocks now make up a larger percentage of your portfolio than you had once intended, the volatility of your portfolio may have increased.
There are a few ways to restore your portfolio, and resume your alignment. You can sell some of your stock, so that the ratio of stocks to other investments drops; you can sell some stock, and invest that money in other assets so they are again at their original percentages; you can add money to the portfolio, and buy more bonds and cash alternatives, or you can do some combination. Many investment advisers recommend using shifts of 5 percent or more, as a trigger for rebalancing. Others recommend that it be done every year. Tax time or year-end is usually a good time to check on your portfolio, and think about rebalancing, if necessary.
You should consider the transaction costs and/or tax consequences that might result from rebalancing. For example, selling investments, as part of your rebalancing strategy, might trigger capital gains tax and/or (in the case of a mutual fund) redemption fees. Before investing in a mutual fund, carefully consider its investment objectives, risks, charges, and expenses, which can be found in the prospectus available from the fund. Read it carefully before investing. As always, if you have questions, please contact the experts at Henssler Financial: experts@henssler.com or 770-429-9166.
Disclosures
The following information is reprinted with permission from Forefield, a division of Broadridge Financial Solutions, Inc. This article is meant to provide valuable background information on particular investments, NOT a recommendation to buy. The investments referenced within this article may currently be traded by Henssler Financial. All material presented is compiled from sources believed to be reliable and current, but accuracy cannot be guaranteed. The contents are intended for general information purposes only. Information provided should not be the sole basis in making any decisions and is not intended to replace the advice of a qualified professional, such as a tax consultant, insurance adviser or attorney. Although this material is designed to provide accurate and authoritative information with respect to the subject matter, it may not apply in all situations. Readers are urged to consult with their adviser concerning specific situations and questions. This is not to be construed as an offer to buy or sell any financial instruments. It is not our intention to state, indicate or imply in any manner that current or past results are indicative of future profitability or expectations. As with all investments, there are associated inherent risks. Please obtain and review all financial material carefully before investing. Henssler is not licensed to offer or sell insurance products, and this overview is not to be construed as an offer to purchase any insurance products.
