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Markets skewing your portfolio? Consider rebalancing

July 28, 2014

A soaring stock market and a slumping bond market may tilt your investment portfolio away from its original asset allocation—as can declining stocks and rising bonds. What's an investor to do?

It may make sense to relax, reevaluate, and, perhaps, rebalance.

When markets move up or down significantly, those results throw many investors' asset allocations out of whack. Times like these are when discipline may be needed the most—but many of us find it difficult to part with assets that have been doing so well while buying others that seem weak in comparison.

Colleen Jaconetti"The goal of a rebalancing strategy is to minimize risk rather than maximize returns," said Colleen Jaconetti, a manager in Vanguard Investment Strategy Group. Without rebalancing, "it's likely a portfolio will become overweighted with stocks and more vulnerable to equity-market corrections," she said. "This puts an investor's portfolio at risk of larger losses compared with the portfolio they intended."

Why rebalancing can help control risk

History shows that stocks have performed better than bonds over the long term, but those returns have come with greater volatility. That's one reason bond funds can play an important role in a portfolio by serving as a cushion for stocks' greater risk. In addition, investors often look to bonds as a possible haven when stocks are falling, so bond returns often follow a different path from the stock market's returns. Rebalancing helps control risk by keeping an investor's allocations to these and other assets close to the target.

Still, "the task of rebalancing is often an emotional challenge," Ms. Jaconetti said. "Historically, rebalancing opportunities have occurred when there was a wide gap between the returns of asset classes such as stocks and bonds."

Rebalancing helped disciplined investors manage risk during two of the harshest bear markets in U.S. history: the technology bubble of 2000–2002 and the financial crisis of 2008–09.

Focus on determining your plan

Vanguard research shows that the overall mix of assets in your portfolio is likely to have a much greater effect on your long-term returns than which individual securities you hold. That means your first priority should be determining the mix of stocks, bonds, and cash that's suitable for your unique goals, time horizon, and risk tolerance. Then you can rebalance as needed when the needle drifts too far from where you set it.

How often might you need to do this? "Annual or semiannual monitoring, with rebalancing when allocations swing 5 percentage points or more from the target, is likely to produce a reasonable balance between risk control and cost minimization for most investors," Ms. Jaconetti said.

Notes:

  • All investing is subject to risk, including the possible loss of the money you invest.
  • Investments in bonds are subject to interest rate, credit, and inflation risk. There is no guarantee that any particular asset allocation or mix of funds will meet your investment objectives.
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