How to keep your portfolio on track by rebalancing

September 1, 2010

Diversification gives investors a valuable tool for managing risk and volatility in an investment portfolio. Effective diversification, however, requires diligent maintenance.

Key Points

Q: If I have a very well diversified investment portfolio, do I still need to make adjustments based on what the markets are doing?

At first glance, rebalancing may seem counter-productive. Why sell a portion of outperforming asset groups and acquire a larger share of underperforming ones? Intuition might suggest that selling previous winners may hinder returns in the future. This logic is flawed, however, since past performance may not continue in the future-and there's no reliable way to predict future returns.

Equally important is that you choose your original asset allocation to reflect your risk and return preferences. Rebalancing realigns your portfolio to these priorities by using structure, not recent performance, to drive investment decisions.

Periodic rebalancing also encourages dispassionate decision making-an essential quality during times of market volatility. Moreover, if and when your overall financial goals or risk tolerance change, you have a foundation for making adjustments. In the absence of a plan, adjustments are a matter of emotion and guesswork.

In the real world, portfolio allocations are usually complex, incorporating not only fixed income and equity, but also the multiple asset groups within equity investing. The more complex a portfolio's allocation, the greater the need for maintenance.

Determining when and how to effectively rebalance requires careful monitoring of performance and awareness of your tax status, cash flow, financial goals, and risk tolerance. Rebalancing also may incur transaction fees and potential capital gains in taxable accounts.

While rebalancing costs are unavoidable, several strategies can help minimize the impact:

The key is to develop a structured plan that remains flexible to each investor's unique blend of goals, risk tolerances, cash flow, and tax status. No one knows where the capital markets are headed, and that's the point. In an uncertain world, investors should have a well-defined, globally diversified strategy and manage their portfolio to implement it over time. Rebalancing is a crucial tool in this effort.

Q: How long do the payments for an immediate annuity last?

A: As a general rule, you can arrange to receive regular payments for a specific number of years or for the rest of your life, or the joint lives of you and a designated beneficiary. Once you decide on the duration of the payments, it will be easier to compare the difference in the rates of return, which are typically locked in once your purchase is made. This differs from deferred annuities where rates can change at specified time periods.

All other factors being equal, the longer the time for payments, the less you will receive with each check. Conversely, you will receive larger monthly payments if you arrange to receive them for just the next 10 years, as opposed to choosing monthly payments over your lifetime, assuming that your current life expectancy is greater than 10 years.

Prior to making the investment, ask the insurance company to provide you with the payout amounts for all time periods available to you.

Joel M. Blau, CFP, (top) is president and Ronald J. Paprocki, JD, CFP, CHBC, is chief executive officer of MEDIQUS Asset Advisors, Inc. in Chicago. They can be reached at 800-883-8555 or blau@mediqus.com
or paprocki@mediqus.com
.