Investors who wish they were better at buying low and
selling high actually have a tool that can force them to do just that. It's
called "rebalancing" - the practice of regularly re-allocating a
portfolio so the investments in it stay in their originally intended
proportions. A 60 percent stocks-40 percent bonds portfolio will get
out of kilter if you leave it alone long enough. To rebalance, you have to cut
back on the portion that grew and add money to the other side.
An investor who does that regularly will protect herself
from taking more risk than she intends. She also will often lock in gains and
buy securities at better prices than she might otherwise. Last year - a boom
year for stocks and a bad one for bonds - provide a classic
example of why investors need to rebalance.
Rebalancing is easy for workers who invest through their
company 401(k) plan. A one-fund program, such as a target date retirement fund,
will be regularly and automatically rebalanced by its managers. Large company
retirement plans often let workers leave standing automatic rebalancing orders,
so their portfolios can be adjusted quarterly or annually.
That works especially well for retirement investors because
there are no tax consequences to their rebalancing efforts. But individual
investors who have non-retirement portfolios of their own have to work harder
to make rebalancing work. That's because their trades often involve some
transaction costs and some tax consequences. And because they may have to
rebalance manually, instead of on autopilot.
Here's how to do it best.
DON'T JUST STICK WITH
With the S&P 500 up 4.43 percent and the bond
index up 5.51 percent, asset allocations haven't changed much. Instead of
regularly rebalancing even small amounts, let the growth of your investments be
Set a band of 5 percent or 10 percent, and when one part of
your portfolio outgrows its intended allocation by that much, start to think
about rebalancing. For example, think 'rebalance' once a 60 percent stock
portfolio turns into a 66 percent stock portfolio. You may miss the top of the
market with part of your investments but you'll take solid earnings off
If you have to rebalance via a brokerage account that has
high transaction fees, rebalance less often. That was the conclusion of a paper
published recently in the Journal of Portfolio Management.
Bank of America's Merrill Lynch and others said
investors facing low costs would do better rebalancing quarterly, those facing
higher costs should rebalance once a year.
PLAN FOR TAX
It's better to hold taxable securities for at least a full
year so they can qualify for lower long-term capital gains tax rates.
You can cut your taxes further by selling your losing
investments while you're selling your winners, to lock in those losses. You can
rebuy the same losing investment in 31 days, or simply buy a similar but
different one immediately to complete the rebalancing.
That way, at tax time they can offset short-term gains and
ordinary income, both of which are taxed at higher rates than long-term gains.
THINK OUTSIDE BROAD
Don't just think of stocks and bonds. Rebalance a global
portfolio when one region runs away from the others. Rebalance a mixed stock
portfolio when growth stocks get away from dividend-producers.
Do this steadily enough and you might turn into one of those
rare finds: an individual investor who buys low and sells high.
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