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Why Should I Rebalance My Portfolio?

Changes in life and the markets may affect your desired asset allocation.

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Maintaining a diversified portfolio is a basic investing principle, but because of economic ebbs and flows, your portfolio is not likely to stay that way without regular housekeeping. You want to regularly revisit your assets to evaluate performance, redistribute asset classes to maximize return and manage risk, and update your portfolio. The process is called rebalancing.

Rebalancing aims to restore your portfolio back to its target mix. For instance, you may have initially allocated 60 percent in equities and 40 percent in bonds, but a few strong years of equity gains have shifted it to 70 percent in equities and 30 percent in bonds. You now have more in stocks than you might want.

To rebalance, you take profit from your best-performing holdings and redeploy it to the investments that have lagged. If your investment goals have not changed, there's no reason your original portfolio allocation should change either.

Is it worth it?

Rebalancing is a risk-control strategy.

No investment category stays on top or bottom forever, yet it's nearly impossible to know when things will change. In the late 1990s, Internet stocks were on fire but crashed in 2000. Then real estate was the must-have investment, only to meet the housing bust in 2007 and 2008. Later bonds were hot but have since cooled with the Federal Reserve tapering program. In other words the market cycles through its favorites.

Because most can't predict the next crash or the new favorite, a diversified portfolio is your best defense. By rebalancing, your portfolio won't be concentrated in the most recent winners or those that are temporarily out of favor. It allows you to protect gains and positions your investments to take advantage of potential coming upswings.

How to rebalance

Consider these pointers to help you get started:

  • Remember your original portfolio allocation: What was it, and why did you want it that way?
  • Compare: How far has your current mix strayed from that target? Experts recommend making changes when your investments are 5 percentage points from your target allocation. For example, a portfolio with 60 percent stocks and 40 percent cash would need to be rebalanced if that mix became 68 percent and 32 percent.
  • Adjust: Take money from the investments that now account for more of your portfolio than you want and direct it to the laggards.
  • Set a schedule: Decide how often you will check your portfolio's balance. At the beginning of each year or once a quarter? A few times a year is probably sufficient.

A few considerations

While one reallocation strategy might be to sell high-performers, you could be taxed on the capital gains you earn. Instead, consider using new money to boost the percentages of the lower performers.

Your goal is to maintain a stable asset allocation, so you don't simply set it and forget it. As you get older and closer to retirement, you may need to adjust your allocation to reflect a lessened risk tolerance and shorter time horizon. A portfolio that was suitable when you were 30 may not be 20 years later. Each time you rebalance, consider if your current life stage or circumstances merit additional portfolio changes. (See sidebar, "How Life Events Affect Investing.")

Ask your State Farm® agent about the tools available to help you identify the optimum asset allocation for your investing goals, time horizon and risk tolerance.

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Asset allocation and diversification do not assure a profit or protect against loss.

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AP2014/05/1006

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