Personal Finance

How to Rebalance While Walking on Eggs

Paul J. Lim|The New York Times

In this volatile market, investors have been understandably preoccupied with the day-to-day swings in stock prices. But instead of fixating on ticker movements, you might better spend your time paying attention to how this slide is affecting your long-term asset allocation strategy.


Asset allocation — or how much you invest in stocks versus bonds — is probably the biggest determinant of the risk and returns you can expect from your portfolio. But in just 10 months, a declining stock market may have already undone some of your plans.

How so? If you started with a portfolio that was 60 percent stocks and 40 percent bonds at the market peak last October, chances are that it’s now closer to a 50-50 mix, as stocks have sunk and bonds have risen. Depending on your age, this mix may be far too conservative to meet your long-term needs — that is, unless you rebalance. But be careful.

Although rebalancing seems a simple concept — periodically booking some profits in assets that are up in order to replenish your stake in those that are down — it’s far more complicated in practice.

If you rebalanced right now, for example, you might sell some shares of a bond fund while picking up a few more shares of a broad market stock portfolio, like the Vanguard 500 Index fund, which tracks the Standard & Poor’s 500-stock index. Well, thanks to several years of market-beating gains, energy stocks now make up 14 percent of the S.& P. 500, up from 6 percent in 2000. This means that by rebalancing back into equity funds, you’ll probably be adding to an already disproportionate weighting in a frothy sector.

Such issues are rarely considered, financial planners say, because few investors rebalance regularly. When times are good, investors neglect doing so because it means having to sell stocks that are soaring — and who likes to sell a winner? And when times are bad, rebalancing means having the courage to buy stocks as prices are tumbling, which few investors are willing to do.

But with the market off about 17 percent from its recent peak, despite Friday’s rally, now is a great time to think about rebalancing. Following are a few suggestions:


“Rebalancing isn’t just about your stocks versus your bonds,” said James A. Shambo, a financial planner in Colorado Springs. “It’s also about your small stocks versus your midcap stocks versus your large-cap stocks.” And, for that matter, it’s also about your domestic stocks versus your international ones.

Say you put 10 percent of your equity portfolio into volatile emerging-market shares at the start of 2005. If you failed to rebalance for the next three years, you would have entered 2008 with more than 17 percent of your money in places like China and India — just in time to see those markets tank.

Since the start of this year, the Indian stock market has fallen 34 percent, in dollar terms, while the Chinese market is off more than 29 percent, also in dollars.


Many investors adjust their holdings once a year, on a specific date like June 30 or Dec. 31. But if you wait until an arbitrary date to rebalance, sizable gains or losses in your portfolio may have already self-corrected.

Consider the October 1987 market crash, when the Dow Jones industrial average lost more than 22 percent in a single day. If you waited until the midway point of the next year to adjust your portfolio, you would have waited too long: The Dow recovered all but about 100 points of its losses by June 30, 1988.

A better strategy is to rebalance whenever your underlying allocations shift by a certain amount — say, 5 percent. If you think your appropriate exposure to stocks is 70 percent, but your stock weighting falls to, say, 65 percent, consider rebalancing.


Be realistic when it comes to rebalancing, said Ronald W. Rogé, a financial planner in Bohemia, N.Y. If you have a small portfolio and rebalancing means selling or buying slivers in positions of $5,000 or less, “then it might not make sense to rebalance too frequently,” Mr. Rogé said.

Why not?

“Because the transaction fees might erode such a sizable percentage of your portfolio, it would defeat the purpose of rebalancing,” he said.

If you owned $5,000 in small-cap stocks and that position shifted 5 percent, you might incur $25 in commissions and taxes to sell just $250 worth of shares.


Over the last five years, the weighting of the typical 401(k) investor in his employer’s stock has fallen to around 15 percent from 25 percent. Does this mean it’s time to rebalance into more shares of your own company?

Absolutely not, said Mike Scarborough, president of Scarborough Capital Management, a 401(k) investment advisory firm in Annapolis, Md. Even though the allocation has been dropping, 15 percent is still too big a stake to own in a single company — especially when it’s your own employer.

“If they’re rebalancing toward more company stock, that would bring me to tears,” he said. “If anything, I would hope they would rebalance away from it even more.”

If you don’t agree, Mr. Scarborough says, you need only ask employees at companies like Bear Stearns or Enron who tied the bulk of their retirement security to company shares.