Let’s be honest. Have you ever spent time looking at how all your investments are allocated (what your investments hold across your entire portfolio of holdings)? If you’re like most investors, you probably don’t give much thought to your mix of stocks versus bonds – but you should!
Understanding your allocation is fundamental to understanding your risk and ultimately how much downside you are willing to accept versus potential downside should the stock market sell off. Here are three key reasons to look at your portfolio and why you should periodically rebalance it:
- Sell what has gone up the most and readjust the investment into investments that have not gone up as much. A fundamental rule of investing is “buy low and sell high.” When part of your portfolio has grown disproportionately large, it is wise to trim some of those dollars (sell high) and reallocate into sensible parts of your portfolio that haven’t grown as much (buy low). More specifically, the rule of thumb often used in the financial services industry is the allocation rule of 5%. That means if the amount of money invested in any one area is 5% out of whack, it is at that point that you bring that investment down to make it realign.
- Checking your investment allocation creates an ideal opportunity to review the investments you are holding. Has a particular investment performed well or poorly? Look into what might have happened to that stock or fund to explain the excellent or poor performance. When looking for research on how your investments perform and finding a replacement investment either, go to a site like Morningstar or consult your favorite financial advisor for guidance on a better performing security.
- Periodically reallocating can help you achieve a smoother rate of return. The stock market moves in cycles. Investments like stocks and bonds go through their own cycles of favorable and unfavorable environments. By making subtle changes to the investment mix and continually optimizing it specific to your investment objectives can give you a chance to sell and buy securities at potentially more favorable pricing. The value of enjoying a smoother return is that you are more likely to stay invested and not panic as long as your account balances do not go haywire!
We recommend reviewing your investment allocation at least four times a year (you can easily put a reminder on your calendar to do it every three months). Don’t expect to make changes every time. And if you use a direct investing platform, like HHWM Direct, portfolio rebalancing is likely done for you automatically so that’s one less item you have to worry about adding to your to-do list!
Michael Carlin, AIF®