Year-end checkup: Time to rebalance?

Investors have been running scared. Through early November, $219 billion was pulled out of stock mutual funds according to TrimTabs Investment Research. That comes on the heels of five straight years of investors pouring cash into their stock funds.

This year has seen a massive flight to safety as investors have shifted to bond funds and other safe havens. Money-market mutual fund assets are up 20 percent so far this year, according to the Investment Company Institute. But now that all that money has shifted around, where does that leave you?

Despite the ongoing market uncertainty, with the end of the year approaching it's a good time to take a look at your 401(k) to see if you need to rebalance your asset allocation — meaning the amount of money invested in various asset classes such as stocks, bonds and cash investments. Market losses and gains, if you have any this year, may mean that your portfolio is no longer in sync with your investment goals.

"Investments are the only thing in the world where people don't want to buy things on sale," said Tom Ruggie, president and founder of Ruggie Wealth Management in Tavares, Fla. Though it's preferable to buy into a down market, he recognizes the reality that investors often stay sheltered for too long because buying in a down market doesn't feel good.

In this market, rebalancing can help prevent you from becoming too conservative. For investors with a longer time horizon, this may mean buying more stock to reflect their higher risk tolerance. Adjusting your portfolio helps to rebalance both your market risk and inflation risk.

For instance if you scaled back your stock investments to limit your exposure to market volatility, you likely increased your inflation risk.

This is because stocks earn the highest rate of return over time. By assuming more risk, stock investors are rewarded with a larger buffer against inflation, which stood at 3.7 percent in October. Witness the 10-year annualized return of 5.4 percent of the Barclays Capital U.S. aggregate bond index.

Many advisers recommend an annual check to see if your allocation fits your level of risk and timeline. Some recommend checking twice a year, even a quarterly checkup may be warranted when the market changes rapidly as it has in the past few months.

"In the market downturn like now, you may need to be at 60 percent stocks going forward and you may only be at 40 percent since the market ran down," said Jack Thurman, president of BKD Wealth Advisors in Springfield, Mo. "You'll need to take money out of bonds a reallocate cash to stocks to get you back to 60 percent."

The first step to a proper balance is deciding how much risk you can handle and how far away retirement is for you. The younger you are and the further away from retirement, the higher your stock allocation should be, perhaps as high as 70 percent.

The closer you are to retirement, the less you should be invested in stocks to avoid losing too much in a down cycle. This is the very tough lesson many of today's near-retirees have learned. Those a few years from retirement with too much invested in stocks lost large portions of their retirement accounts.

"If investors are close to retirement and they've been heavily invested in equities at this point it's a little bit like the horse is out of the barn," said Dean Kohmann, vice president of 401(k) plan services for Charles Schwab & Co. Inc. "To go back and try to get a conservative allocation now, it's a tough decision because essentially you're locking in your losses."

If you're in retirement and living off a portion of your account, many advisers would say stock allocation should be smaller, Schwab's recommended conservative allocation is 20 percent stocks, for example, to minimize risk.

It's best to have a system for setting the asset allocation so that you're not reacting emotionally.

Advisers recommend setting a target mix — many suggest 60 percent stocks, 35 percent bonds and 5 percent cash funds for medium-risk investors.

The reason why you want a disciplined approach is there's a natural reluctance to take money out of funds that have performed well and put it into something that's not doing so well. It's tempting to stick with the winner.

Many advisers say if your stock, bond or cash allocation moves more than 5 percent from your target, you should rebalance. For example, if you're 40 percent in stocks has fallen to 33 percent, while your bond fund allocation has increased, you should move money from bonds into stocks to get back into balance.

Many 401(k) plans offer options such as automatic rebalancing through the plan provider's secure Web site. Such plans typically allow you to pick an asset allocation and periodically rebalance to those levels. This is done by selling shares in the funds that have grown larger than your target allocation and are invested in those that have shrunk too low.

Some plans also offer target-date funds or life cycle funds, which automatically reduce your risk exposure as you approach retirement. Issues you may want to be weigh before going into these funds include their cost, whether they are actively managed or passive and the fact that they likely invest in their own family of funds, narrowing the diversity of your portfolio.

So if you're not inclined to stay on top of your 401(k) plan, you may want to inquire as to whether your plan offers one of these automatic options. If you're like many investors, they may be a new features that haven't hit your radar.

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If you want to learn more, here are a few recommendations:

_The Financial Industry Regulatory Authority Inc. has details on managing your 401(k) account at:

http://apps.finra.org/Investor_Information/Smart/401k/000100.asp

_Morningstar Inc. also offers a tool to look at the funds in your 401(k) to make sure you're not too heavily invested in one stock. The Portfolio X-Ray is at: http://portfolio.morningstar.com/NewPort/Free/InstantXRayDEntry.aspx?dt0.70

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Have 401(k) questions of your own? Send them to: dpitt(at)ap.org

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