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Rebalancing reduces risk

- Alan Lavine and Gail Liberman

In the wake of the three-year bear market that has seen stocks drop almost 50 percent, it is important to practice whatís known as "asset allocation" and "portfolio rebalancing" for protection.

With asset allocation, you invest in a variety of investments. Many people, for example, invest in stocks, bonds, cash and real estate or even gold. This way, when one of these investments zigs, the other zags. The result is that overall, you have a less volatile investment.

With "portfolio rebalancing," you can avoid having too much money in any one type of investment. At least every year, you should adjust your investments so that you have the same percentage of money in each. Say the asset-allocation mix you wish to maintain is 60 percent stocks and 40 percent bonds. Over the last year, bonds did well, so you suddenly find yourself with 60 percent of your money in bonds and 40 percent in stocks. You would take your 20 percent profits and put them back in bonds so that you have the same mix as you originally wanted. Anyone who practiced portfolio rebalancing over the last three years would not have been hurt nearly as badly in the latest bear market as those who didnít.

Harold Evensky, author of "Wealth Management (McGraw-Hill)" says that you stand to get a better return if you buy and hold stocks and bonds. The problem: Many investors eventually have too much money in stocks. This can be risky as weíve recently learned the hard way. Portfolio rebalancing certainly can help avert this situation.

Asset allocation and portfolio rebalancing help reduce the risk of financial market losses, according to a study by Ibbotson Associates, Chicago. If you had 60 percent in stocks and 40 percent in bonds over the past 25 years, and rebalanced this mix at least annually, you would have cut your risk by 25 percent, the study says. Rebalancing delivered a higher return per unit of risk compared with an unbalanced mix of investments.

If you hold stocks and bonds with different investment styles, you can produce a less volatile performance over the long term, adds research in the Financial Analyst Journal. Itís not the exact stocks or bonds you pick that determine performance and volatility. Rather, 94 percent of the return is based on how you allocate your assets.

So where can you get asset allocation and portfolio rebalancing advice? You can check with a financial adviser. He or she can help you evaluate your tolerance for risk. Then the adviser can structure your holdings so that they deliver the best return with the least amount of risk.

If you own MFS or Oppenheimer mutual funds, those fund groups will automatically rebalance a portfolio of their funds for you.

You can purchase some software or go online for free advice. Microsoft Money is a popular program. No-load mutual fund groups like Fidelity, Vanguard and T. Rowe Price also have online asset-allocation programs.

If you want to keep it simple, invest in a balanced fund. These funds maintain a 60 percent stock and 40 percent bond mix. They rebalance periodically if there is too much money in bonds or stocks.

There also are asset-allocation funds that split investments among stocks bonds and cash and rebalance automatically. Top-rated asset allocation funds according to Morningstar Inc., Chicago, include: Vanguard Asset Allocation and Fidelity Asset Manager.


Alan Lavine and Gail Liberman are husband and wife columnist and authors of The Complete Idiot's Guide To Making Money With Mutual Funds, (Alpha Books).

To read more columns, please visit the column archive.

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