It’s not quite a Shakespearean dilemma, but lots of investors are wondering: To rebalance, or not to rebalance? The standard advice is that when prices run up in one asset, you should lighten up and use the money to buy lagging assets. That way, your overall allocation stays in line with your plan. If you started 2013 with a mix of 60% stocks and 40% bonds and you’re closer to 65%-35% now, you’d be obliged to sell some stocks and buy bonds.
But when forecasts call for rates to rise—and, therefore, bond prices to drop—it’s little wonder that investors are loath to buy an asset that they’re convinced is heading south. “The problem is that bond prices just don’t look attractive,” says New York City adviser Lew Altfest. For some of his clients, he says, “we’re practicing something we call benign neglect—ignoring the fact that stocks are overweighted, given the choices.”
Altfest has many years of experience and has seen all kinds of markets. But for many investors, it’s dangerous to ignore a proven strategy for the worst of all reasons—that is, because “this time, it’s different.” A study by the Vanguard Group compared portfolios that were rebalanced with those that were not, from 1926 through 2009. A never-rebalanced portfolio starting with 60% stocks and 40% bonds drifted to 84% in stocks and returned an annualized 9.1%. A 60-40 mix rebalanced annually returned 8.6% a year—a smidge less, but also with 17% less volatility, a proxy for risk. The closer you are to retirement, the more dangerous a “let it ride” philosophy becomes.
Despite heightened risks, bonds still provide stability in a portfolio. “All bonds are not created equal,” says Dan Moisand, an adviser in Melbourne, Fla. “Stick with modest durations [a measure of interest-rate risk] and good credit quality,” he says. “Even if rates spike, you won’t get killed.” Trade long-term Treasuries for short-term notes or corporate bonds (both of which are less sensitive to rising market rates), or for floating-rate bank-loan funds, which hold up well when rates rise (see Get 3% With Low Risk).
If you’re having a hard time sticking to your asset-allocation plan, try to think of a diversified portfolio as a little like a baseball team, says investment strategist (and St. Louis Cardinals fan) Gary Thayer, of Wells Fargo Advisors: “Not a lot of people hit the ball to right field. But you don’t take the right fielder out of the game."
Anne Kates Smith brings Wall Street to Main Street, with decades of experience covering investments and personal finance for real people trying to navigate fast-changing markets, preserve financial security or plan for the future. She oversees the magazine's investing coverage, authors Kiplinger’s biannual stock-market outlooks and writes the "Your Mind and Your Money" column, a take on behavioral finance and how investors can get out of their own way. Smith began her journalism career as a writer and columnist for USA Today. Prior to joining Kiplinger, she was a senior editor at U.S. News & World Report and a contributing columnist for TheStreet. Smith is a graduate of St. John's College in Annapolis, Md., the third-oldest college in America.
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