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2005: Where to Invest

Investing Is a Rebalancing Act

By Mike Anderson
Special to The Washington Post
Sunday, January 2, 2005; Page F01

When the stock market looked bleak this summer, did you panic? Did you sell?

If you stood by your stocks, by year's end you had your reward. The Dow industrials -- down deeply this summer and through the fall, finished 2004 up nearly 3.2 percent. The broader Standard & Poor's 500-stock index gained 9 percent, and many small-cap stocks and funds were up 15 percent or more, while hot sectors such as energy and real estate were up about 25 percent or more.

Intel, whose chief executive, Craig R. Barrett, is shown, lagged this year but could rebound. (Louis Lanzano -- Bloomberg News)

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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."
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So drink to 2004, but the start of 2005 may be the time to give some thought to the more sobering matter of risk in your portfolio. Resisting a knee-jerk reaction to midyear market weakness was right, but now, with a relatively strong year in the bag, selling some of your best gainers could be a winning strategy. Indeed, last year's successes can turn into this year's excesses -- meaning too little diversity and too much risk of future investment losses -- if you don't occasionally heed a time-tested strategy: portfolio rebalancing.

Most simply, rebalancing means reconciling your long-term investment strategy with your actual returns and making adjustments. It's a simple concept that is nevertheless hard for many people to follow. First, the idea of selling winners and stocking up on recent laggards can seem contrary to human impulses.

"It's very hard to say, 'I'm going to sell the thing that's doing the best and put my money into something that lost money or is lagging the markets,' " said Catherine Gordon, director of investment counseling for the giant mutual fund company Vanguard Group and a leading advocate of rebalancing. "Rebalancing is not trying to earn excess returns. It's a way to control risk."

The more money you allocate to a single class of assets -- stocks, bonds, small stocks, foreign bonds, etc. -- the more you are at risk of wiping out your gains due to a reversal in that asset class.

Another rebalancing challenge is acknowledging that, in the long run, no one can predict how markets, and especially individual stocks, will perform each year.

Clients frequently ask Louis P. Stanasolovich, president of Pittsburgh's Legend Financial Advisors Inc., why his firm didn't hold onto a particular share or fund longer to fully enjoy the gains. "I tell them we avoid risk first, go for returns second," he said. "If you don't lose money, you don't need that big of a gain to come out ahead."

Stanasolovich's firm, which manages about $215 million in assets, shows the pros and cons of balanced investing. Focused on consistency rather than matching market indicators, he acknowledges that Legend has lagged major stock indexes a few years since 1998, including 2004. "Initially, we were wrong," Stanasolovich said.

On the flip side, Legend boasted positive returns in the bear market years of 2000, 2001 and 2002. And while he says investors should brace for annual returns of 1 to 2 percent in stocks, 2 to 3 percent in bonds and 3 to 5 percent in real estate over the rest of this decade, his firm aims for total annual returns of 7 to 8 percent a year.

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