Sometimes, the little things in investing can seem kind of boring.
Many of us -- I'm no exception -- would rather talk about Apple CEO Steve Jobs' new venture into social networking and its prospects for broadening the company's reach, or spend time hunting up fat-yielding dividend stocks like Kimberly-Clark, which has raised its dividend a whopping 38 years in a row.
Those are interesting, exciting topics for investors. Things like asset allocation or rebalancing? Not so much.
But those are the kinds of little things that can make a big difference -- especially when those little things get to compound over time.
Rebalancing, and why it matters
Rebalancing, simply put, is the art and science of periodically resetting your portfolio to your intended asset allocation. A good asset allocation strategy is key to getting steady returns with well-managed risk over time, but price movements over time can mess up your ratios.
For instance, suppose that your plan called for a certain allocation to cyclical industrial stocks, and a year ago you'd split it 50-50 between Ford (NYSE: F ) and Dow Chemical (NYSE: DOW ) .
A year later, how's it look? Ford's spectacular turnaround may well be one for the history books, as the company has continued to launch top-notch products while staying intensely focused, increasing sales and capturing market share from competitors like Toyota (NYSE: TM ) around the world. And the stock has followed along nicely, going from about $7 to about $12 over the period.
Dow Chemical, on the other hand, has been more of a mixed bag, taking investors on a wild up-and-down sleigh ride that, a year later, has ended up pretty much where it started. A strong first quarter, ironically, led to a price decline as investors began to question the company's long-term prospects. Second-quarter results that came in below expectations -- lagging key competitors like DuPont (NYSE: DD ) -- seem to have left investors scratching their heads, as the share price has gyrated around the $26 mark. Still, there may be reason for optimism, as the company reported double-digit growth in seven of its eight business segments and could see solid appreciation going forward.
Long story short, your hypothetical allocation now might be more of a 65-35 ratio than the 50-50 ratio called for in your plan. And while Ford shareholders might object to this suggestion, this might be a good time -- assuming you still believe in the long-term prospects of both stocks -- to sell some of that Ford stock and buy a little more Dow Chemical. Not only will that move restore your intended 50-50 allocation, it'll -- pay attention here -- get you more Dow Chemical while it's relatively cheap.
It's kind of like an automatic value investing system, or as my fellow Fool Dan Caplinger put it recently, like shopping at the mall, buying things when they go on sale.
The right way to rebalance
Foolish retirement guru Robert Brokamp is a big proponent of rebalancing for long-term portfolios, and he has an article in the new issue of the Fool's Rule Your Retirement newsletter that digs into the pros and cons of rebalancing strategies in detail.
There's definitely a case to be made that rebalancing every year or so isn't always the best move, in retrospect; there's some merit to the old Wall Street adage to "let your winners run." But as a consistently applied discipline, rebalancing will tend to reduce your overall risk and increase your returns over time.
Yes, I said "increase your returns," despite the sense that you might sometimes be selling winners to buy laggards. It may seem like rebalancing doesn't buy you that much -- and in a short-term sense, it usually doesn't. But when you rebalance your portfolio every year or two over a few decades, it can make a sizable difference -- thanks to the power of compounding.
Consider: Robert's article looks at an example where $100,000 invested in 1972 would have yielded about $4.3 million today -- unless you rebalanced every year, in which case you could add another $330,000 to that total. While $330,000 may not seem like much compared to $4.3 million, it's still three times your original investment. Who wouldn't like to get to retirement with another $330 grand to spend, especially when that money only takes you about an hour a year to earn?
If you'd like to learn more about rebalancing -- and a useful key to managing your portfolio's risk that you might not have thought about -- check out Robert's article in the new issue of Rule Your Retirement. Rule Your Retirement is a paid service, but you can get full access right now with a no-obligation 30-day free trial. Just click here to get started.
Think you've "outgrown" the need to rebalance? Think again -- Dan Caplinger knows why retirees still need stocks.