Rebalancing after the stock rally

stock rallyDespite the uncertainties in Europe and the sluggish U.S. economy, the U.S. stock market has seen a dramatic move upward since October of last year. In fact, the market is on pace for the best first quarter since 1998.

While it is certainly encouraging for investors to open their statements and notice gains again, many analysts believe the roller-coaster ride may not be over just yet.

The fact remains that there continues to be significant risk to a global economic recovery. Considering the significant short-term increase in the value of the market, now may be a good time for investors to review their portfolios to ensure that they are still properly allocated.

One tool that may prove effective in helping to manage risk is the process of portfolio rebalancing. The primary goal of rebalancing is to bring the different investments that make up an investor’s portfolio back into proper alignment. The mix of stocks, bonds, cash and alternative investments that comprise an investor’s portfolio should be selected based upon the investor’s unique risk tolerance, time horizon, goals and objectives. As the markets fluctuate over time, the original target mix changes, altering the amount of risk in the portfolio.

If you haven’t adjusted or rebalanced your portfolio recently, you are not alone.

According to Fidelity, only 11 percent of retirement plan investors made any rebalancing changes in 2011. In theory, rebalancing may help investors accomplish a feat that many find difficult to execute — buying low and selling high. It takes serious discipline to sell investments that are performing well while exchanging them for others that may have underperformed.

There are many important considerations when determining how to rebalance a portfolio and different approaches may serve some investors better than others. The three T’s of rebalancing — timing, taxes and transaction costs — all affect the decision-making process.

One approach to rebalancing is based upon choosing a specific duration — quarterly, semiannually, or annually to reset the portfolio back to the original mix. While some find value in the simplicity of this approach, others see the merits of rebalancing based upon certain targets. An example of this would be choosing to rebalance when any portion of a portfolio is 5 percent above or below the original target.

For instance, let’s assume that an investor chooses to allocate 50 percent in stocks, 45 percent in fixed income and 5 percent in cash. If, due to the recent rally in the market, the stock portion of the portfolio rose to 55 percent, a rebalance would occur that would reset the portfolio back to the original target allocation.

Finally, some investors may utilize a combination of the two approaches by monitoring the portfolio regularly and then rebalancing based upon a specified threshold. In fact, according to Vanguard, a rebalancing strategy based upon a semiannual or annual review along with the usage of a 5 percent deviation, may be optimal in providing risk control for broadly diversified portfolios over the long term.

After you have established the timing, review the tax implications. Any time you choose to buy or sell investments, a capital gain or loss could be realized, and tax rates differ between long-term or short-term gains. While you may not have to be concerned with taxes in an IRA, 401(k), or other tax-deferred retirement account, you may have reason to worry within a taxable account. Start by rebalancing your retirement accounts first and then consult your tax adviser to determine the tax impact of rebalancing any taxable accounts.

Finally, keep in mind that you must also consider the impact of sales commissions or transaction fees as they, too, can diminish investment returns. Generally, the more often you rebalance, the more tax and transaction fees you may realize.

If it has been a while since your last portfolio checkup, it may be time to review your accounts and consider the benefits of rebalancing. Since each investor’s goals are unique, consider reviewing the details of your situation with your adviser.


Kurt J. Rossi, MBA, is a Certified Financial Planner Practitioner. He can be reached for questions at (732) 280-7550 or LPL Financial Member FINRA/SIPC.