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Maintaining Your Portfolio

Regular Tinkering Keeps Allocations in Check

By Mike Anderson
Special to The Washington Post
Sunday, January 2, 2005; Page F06

It's the beginning of 2005. Do you know where your assets are?

You may have set a solid asset allocation -- a long-term strategy that aligns your assets with your investment time horizon and your tolerance for risk. But even if you haven't tinkered with your plan or your investments, your portfolio may have morphed into something you barely recognize.

_____2005: Where To Invest_____
Risks Cloud a Sunny Forecast (The Washington Post, Jan 2, 2005)
Big Deals, Big Firms Rule Picks (The Washington Post, Jan 2, 2005)
Investing Is a Rebalancing Act (The Washington Post, Jan 2, 2005)
Fees Take a Bite From 401(k)s (The Washington Post, Jan 2, 2005)
Options Exist to Hedge Against Rising Interest Rates (The Washington Post, Jan 2, 2005)
_____Cash Flow_____
Crenshaw No-Leak 401(k)s: Albert B. Crenshaw writes, "One of the key problems that continute to beset 401(k) and related retirement savings plans is what experts call "leakage" -- the tendency of account holders to withdraw their money when they change jobs and spend it."
_____4th Quarter Funds_____
Research your mutual funds' performance for the fourth quarter of 2004:
Best Funds of 4Q 2004
Biggest Funds of 4Q 2004
Worst Funds of 4Q 2004
Get More Funds Quotes

How? It's likely that certain assets in your portfolio have appreciated, while others have fallen in value. The gains may be bigger than your losses, and that's good, but your investments may still be out of balance. Specifically, appreciation of some assets may have left you overinvested, or overweight, in those categories, while you may be underweight in losing sectors, even though the number of shares you own hasn't changed. The same could be true for allocation of stocks vs. bonds or U.S. stocks vs. foreign stocks.

Over time, these problems may take care of themselves, because historically most types of assets have tended to move toward the same long-term return. But that doesn't mean you can afford to wait passively. If your portfolio has fallen out of balance, you may have more risk of investment loss than you realize.

For example -- and we'll use a hypothetical designed to make the math easy; this is not a recommendation -- let's assume that at the start of 2004, you had a $100,000 portfolio and allocated 10 percent to the pharmaceutical sector and 10 percent to oil stocks and mutual funds. By the end of the year, you will be out of balance.

How did you get that way? Let's start with your $10,000 in oil investments at the start of 2004. In the year that just ended, investors learned that the war in Iraq was not exactly going well. That raised concerns about the supply of oil. Meanwhile, demand was as strong as ever, thanks in large part to the strength of China's economy. The result was a big increase in oil prices and oil stocks, even after crude prices eased at the end of 2004.

Assuming your oil and energy investments are up 32 percent for the year, consistent with the gains in the exchange traded fund representing major oil companies (XLE), your oil investments are now worth $13,200.

But then you have the pharma shares. Problems with Merck & Co.'s painkiller Vioxx, as well as concerns that Pfizer Inc.'s Celebrex may also cause heart problems, made pharmaceuticals one of the worst places to be in 2004. The ETF representing the pharmaceuticals industry (PPH) was down about 9 percent for the year, after trading even lower for much of the year. So your pharma investments are now worth just $9,100.

The good news is that your portfolio is up 2.3 percent overall for the year, assuming, somewhat unrealistically, that all your other investments broke even. The bad news is that even though you didn't buy or sell shares, your portfolio now differs from your asset-allocation plan. Following 2004's strong gain, energy now constitutes 12.9 percent of your portfolio, and pharma now represents just 8.9 percent. That's quite a divergence in just one year from your 10 percent plan.

Ignoring all other factors (for instance, whether it's really a good idea to have 10 percent in these two sectors), to stay balanced, you should sell a portion of your oil stocks and buy pharma stocks so that each sector represents $10,230, or 10 percent, of your total portfolio.

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