I'm still hearing about people who are only now mustering the courage to look at the damage their portfolios took from last fall's global economic barfing fit. When you do look, one of the things you'll probably notice is that your asset allocation has drifted a long way from where it was a year or two ago.
Normally, that's your cue to rebalance. And that's what many, even most, experts would advise. While I strongly urge you to take some action, I'm thinking that rebalancing might not be the thing to do right now.
What's this rebalancing thing?
Rebalancing is what we call the act of returning your portfolio to your intended asset allocation, by selling the stuff you have too much of (usually because it has gone up in value) and buying more of the stuff you need (usually because it hasn't gone up in value). It is, or should be, a regular activity for most investors. Because different asset classes appreciate (or take losses) at different rates at different times, your portfolio will naturally get out of whack over time.
For instance, if you had a portfolio that had 15% allocated to each of four stocks -- say, Apple (NASDAQ:AAPL), Starbucks (NASDAQ:SBUX), Sirius XM Radio (NASDAQ:SIRI), and Best Buy (NYSE:BBY) -- when you set it up three years ago, and 40% allocated to U.S. Treasuries, those percentages are going to look a little different this morning. (I trust I don't need to do the math to show you why.)
That's why every time financial planners get interviewed by the local TV news these days, they go on about the importance of rebalancing. And they do have a point. In general, it is a good idea to rebalance your portfolio every couple of years to ensure that it's properly balancing risk and reward consistent with your long-term goals and tolerance for excess stomach acid.
Rebalancing isn't a big deal, especially in most retirement accounts. In a 401(k) or an IRA held at a discount broker like Scottrade or Fidelity, the cost of selling or buying (or of not selling or buying) is mostly just opportunity cost -- in other words, you lose out on whatever you could have done instead (plus a few bucks for commissions on the trades).
Given that perspective, why wouldn't you rebalance?
Why you shouldn't rebalance
Rebalancing definitely has its place, but I'm not the world's biggest fan of frequent rebalancing, and I actually think it's not what many folks should be doing now. My fellow Fool Dan Caplinger -- who is usually a rebalancing advocate -- looked at objections to rebalancing in a recent article. I'll point you there for the full scoop, but here's a quick summary of the key objections to rebalancing as Dan saw them:
- Your goals or risk tolerance might have changed. Dan noted that Vanguard founder John Bogle recently told the Fool that he wasn't inclined to rebalance his portfolio after last year's crash, because his post-crash allocation ended up heavy in bonds and at his age he's fine with that.
- Costs. Not usually an issue in retirement accounts unless you use a fancypants broker for your IRA, but relevant for those in taxable accounts, as I noted above.
- Your investment views might have changed. The sector weights you chose two to three years ago might not be what you want now. Overweighting financial stocks didn't look like a bad bet in 2006, but do you really want to put more money into JPMorgan Chase (NYSE:JPM), Goldman Sachs (NYSE:GS), or Wells Fargo (NYSE:WFC) right now? (Maybe you do. But you should do it after careful thought, not automatically as part of rebalancing.)
All of those points are valid. But that doesn't mean you should just leave things as they are.
What to do instead
Here's the way I prefer to look at the rebalancing question: Never mind what happened yesterday. Never mind what you decided your "risk tolerance" was five years ago, or what that stupid automated tool on your 401(k) plan provider's website said you should do way back when. Never mind what you paid for what you own, how far in the red (or black) you are, how likely any of it is to "come back" in coming months. Forget about all of that.
Just answer this question: What portfolio do you want to own right now? You have the assets you have. If you found that your broker had accidentally sold everything and left you with only a cash balance in a money market fund, what would you buy? Looking only forward, forgetting all about how you got here, how do you want to be positioned?
Back in October, I suggested that investors take advantage of the across-the-board drop in stock values by selling the portfolio they had and buying the portfolio they wanted. In normal steady-as-she-goes times, doing that might well look just like rebalancing. If -- after thinking it through -- you're happy with your investment selections and your original asset allocation, then by all means do a simple rebalance and call it a day.
But if not, now's the time to take what you have left and build the portfolio you really want. Get a good asset-allocation template -- the model portfolios maintained by the Fool's Rule Your Retirement service are the best ones I know of, far better than what most 401(k) providers will give you -- and rethink the whole thing, top to bottom. Take some time to get it right.
I do want to emphasize that last point: Getting the right allocation template is the key to success here. If you'd like to check out the Rule Your Retirement model portfolios, just grab a free trial for 30 days of full access. Once you're logged in, click on the "Resources" tab and you'll see the link on the left. Click here to get started.
