4 Ways to Spread Your Risk

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Do any investments in your IRA, 401(k), or other retirement accounts keep you up at night? Then I've got one word for you: diversification.

In order to get some quality Zs, you need a solid asset-allocation plan -- meaning a portfolio with a bunch of investments that don't always move in the same direction.

To accomplish that, it all comes down to -- you guessed it -- diversification. Please have a seat.

Spread the wealth
Think of portfolio diversification like having a bunch of prom dates lined up: If one turns you down, you're not completely crushed, because you've arranged for a backup date -- one you're pretty sure will be giddy at the sight of your powder-blue tux and seasoned moonwalk.

Does that describe your portfolio? If not, it's time for an annual investment makeover -- or, in Wall Street-speak, it's time to rebalance your portfolio.

Bring re-balance to your portfolio
Rebalancing simply means buying and selling investments to minimize your exposure to risk. The concept is simple, but the execution can get complicated, particularly if you have multiple investment accounts (those IRAs -- Roth and traditional, old 401(k)s, current 403(b)s, etc.).

At The Motley Fool, we're believers in four main rebalancing strategies:

  1. The Add and Subtract Strategy: The easiest way to rebalance is to do the dirty work when you invest new money or make a withdrawal. For example, if you have mostly domestic large-cap stocks in your portfolio, you might invest in some international funds or stocks with your next IRA contribution check. Doing just that may not be enough to fully rebalance your portfolio, however. If that's the case, also use one of the following strategies.
  1. The Mothership Strategy: If you have one account that contains the majority of your assets, lucky you: Concentrate on rebalancing in that account, particularly if it's a tax-advantaged account that doesn't charge commissions (e.g., an IRA invested in no-load mutual funds). Any smaller accounts that are outside your Big Kahuna "mothership" savings can stay invested as is.
  1. The Every Portfolio Is an Island Strategy: If you have several accounts that are of approximately equal value, treat each account as an individual portfolio. That means moving around the money within those accounts so that each portfolio has roughly the same mix of assets. To avoid getting sideswiped by fees, pay attention to the account's tax status.
  1. The U.S. Large Caps in Every Pot Strategy: Chances are that U.S. large-cap stocks make up the biggest piece of your portfolio (as is the case with most investors). Given their size and volatility, this single asset class tends to grow or shrink way beyond its original allocation. If you've got many accounts, holding a position in large-cap U.S. stocks in each makes it easy to increase or decrease your exposure. Because they tend to be tax-efficient, it can also be one of the cheapest ways to right your ship.

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Comments from our Foolish Readers

Help us keep this a respectfully Foolish area! This is a place for our readers to discuss, debate, and learn more about the Foolish investing topic you read about above. Help us keep it clean and safe. If you believe a comment is abusive or otherwise violates our Fool's Rules, please report it via the Report this Comment Report this Comment icon found on every comment.

  • Report this Comment On July 13, 2009, at 10:44 PM, konchan5009 wrote:

    I have an IRA, I'm retired and at the moment, I am down about 75 grand or a previous total of 180 grand. Everything is in mutual funds.

    I am not making contributions so that leaves me with one option (as I see it). Sell at a loss in order to rebalance my portfolio.

    Does this make sense?????????????????

  • Report this Comment On July 18, 2009, at 10:19 AM, garthadams wrote:

    I took a loss on about half my mutual funds and made it back on individual Motley stocks the last 3 months. That said, last months performance is no guarantee of the future!

    In my opinion, mutual funds are dead.

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