Monday, June 22, 2009

Should You "Rebalance" Your Portfolio?

Before we dive into this, let me give you some perspective. Washington DC-based Employee Benefit Research Institute estimates that somewhere in the neighborhood of 50 million Americans have 401(k)s, equaling an estimated $2.5 trillion.

And the Center for Retirement Research at Boston College tells us that in the 12 months following the stock market’s peak on October 9, 2007, “the Dow Jones Industrial Average plunged 39 percent, the Standard & Poor’s 42 percent, and the broadest gauge of market activity – the Wilshire 5000 – 42 percent.” Essentially, about $2 trillion

Unless you’ve been living on Mars, you are aware that the chaos in the stock market is still raging. And, as one would expect, a lot of folks are basically freaking out. Who wouldn’t? Everyone who’s got any money left in the market is looking for some sort of solution to stop the further exhaustion of their investments.

One solution that seems to be gaining popularity is “rebalancing.” In the real sense of the word, rebalancing is the act of returning a portfolio to its original mix, when it no longer conforms. However, for the purposes of this blog, I am defining “rebalancing” as moving assets from one class to another to prevent further hemorrhaging of an account’s value – hence the quotes.

More and more 401(k) plan administrators, customer service reps, and financial advisors are proposing “rebalancing” as a way out of the current mess. But is this really a sound idea? Let me give you the whole story so you can make your own decision, as we at Laser Financial Group always allow our clients – or anyone, for that matter – to do.

First, Get an Understanding

Okay, let’s say you are Barbara, and before this whole stock market pandemonium began, your 401k – or similar plan – had a $300,000 balance. To keep it really simple, let’s assume you own 10,000 shares of Mutual Fund X, making each share worth $30.

When Barbara receives her annual statement 12 months after the chaos begins, her balance has been reduced to $200,000, without her having withdrawn a penny. This means that each share is now worth $20, but she still owns the same number of shares – 10,000. Again, we’re keeping things very simple to help you make wise choices.

Barbara, just like millions of other distraught investors, makes a few phone calls and is “advised” that the “solution” is to “rebalance” her portfolio into a money market fund until after the market recovers. Then she can once again “rebalance” it, back into Mutual Fund X or any other fund that might be “smoking hot” at the time, in order to make money. Sounds pretty awesome, right?

If Barbara were to follow that advice, this is what she would actually have done. She’d have SOLD her shares in Mutual Fund X at their current value of $20 per share and BOUGHT new shares in something else with the proceeds. In other words, she would have essentially made the $100,000 decline in the value of her account permanent.

When and if the market were to recover and the price per share of Mutual Fund X goes back up to $30 and Barbara were to decide to go back in and “make money,” as the so-called advisors suggest she should, she’d be starting with $200,000. In other words, the fund would now be back at $30 per share, but she would own only 6,666.67 shares. Although it may seem elementary, please notice that Barbara now has $200,000, not $300,000, so she no longer has 10,000 shares of fund X.

If Barbara Had a Longer Time Horizon

If you read my columns, you are by now probably aware that I do not claim to have a financial crystal ball. Neither do I posses the ability to predict the exact future movements of the stock market, although that would be awesome! But, I DO have loads of common sense. Oh, before I forget, here is one guaranteed prediction about the stock market for you: It will fluctuate.

Without claiming that past performance is any indication of the future, the fact is that the stock market has, in the past, always recovered. That being said, here are a few questions Barbara needs to ponder before she acts:

  • Do I understand what I own?
  • Why did I invest in the stock market in the first place?
  • Do I need all of my account’s value right now?
  • Do I even believe the market will recover?
  • Do I have enough time to wait for the market to recover?

If Barbara Has “No” Time

To be precise, if Barbara is already retired or very close to retirement, it would be tremendously unfortunate if she found her portfolio in this predicament, because she would simply be out of luck. Unfortunately, this was precisely the case with far too many Americans who’ve been invested in the stock market as it collapsed.

What Am I Saying to Barbara?

As always echoed by Laser Financial Group, it is better to be in a position to act, rather than react to circumstances over which you have no control – like what the stock market is going to do.

None of our clients have lost even a penny during these turbulent times, and they definitely are not looking to do any “rebalancing.” I call that common sense, peace-of-mind investing. You see, financial advisors – or the people they get their financial advice from (including myself) – do NOT have the ability to predict the exact future movements of the stock market. If that were the case, we’d all probably be retired on our own islands, not advising folks like you.

I believe that Barbara and most investors are very smart. Once they receive the correct information in a clear, simple, factual manner, they can make up their own minds as to what is good for them. We have helped people just like Barbara make the good decisions that fit their particular sets of circumstances.

1 comment:

  1. I think this is an excellent piece. I particularly like the way you take your time to make things simple for people like me to understand and make up our own minds.

    Given that there is a lot of noise these days in the financial field, I find your blogs stand out uniquely. Thank you for giving us the truth.


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