Investing Is a Rebalancing Act

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

"A lot of energy stocks are still among the most undervalued stocks on the exchanges," Weissman said. Some of his favorites in the sector are Devon Energy Corp. (DVN), ConocoPhillips and Peabody Energy Corp. (BTU), the world's largest coal company. His firm holds positions in all these companies.

As for the battered pharmaceutical sector, investors should consider more than rebalancing before they hunt for bargains. The entire sector is reeling -- though it has recovered somewhat from 2004 lows -- as once-hot drugs such as Vioxx, sold by Merck & Co. (MRK), and Celebrex, sold by Pfizer Inc. (PFE), have been linked to heart problems in some tests. Now there is concern that every drug company could be confronted with similar problems and that product liability lawsuits could weigh down the industry for years.

Still, even this risk is not necessarily a long-term red flag. It's possible that investors already have factored in the long-term risks to stock prices. But there are other reasons for caution -- existing patent protection expiring on older drugs and no new blockbusters on the horizon, limiting the upside for drug companies.

Adam Greene, First Albany Corp.'s pharmaceuticals analyst, follows six companies and has a buy rating on just one, Wyeth (WYE). He recently downgraded Pfizer to neutral. These companies were the "best of the worst," he said. "This group hasn't had any major discoveries in several years, and that is their lifeblood." The companies are also seeing revenue pressure, and their quality of earnings has been "pretty poor."

Whether you do it yourself or use a mutual fund or money manager, it's critical to remember that sector balance is just the beginning. There are other issues to consider, such as large-cap stocks vs. small ones, U.S. stocks vs. foreign issues and, of course, the classic question, stocks vs. bonds.

Contrast the large-cap S&P 500, up 9 percent, with the Russell 2000 small-cap index, up 17 percent.

"People are definitely overweight in small caps," said Benjamin W. Shoval, president of the Shoval Group, a New York-based hedge fund that manages about $29 million in assets. His advice: Sell some of your small-cap funds and get into a diversified bond fund. In 2004, "people actively sold bonds and spent the money on small caps," he said, "because bond yields were so low."

Indeed, low bond yields and the likelihood of higher interest rates in 2005, which means lower bond prices, has many investors tempted to tear up their long-term asset-allocation plans and underemphasize bonds. (See accompanying story at the top of the page.)

Whether it's bonds or stocks, geographical diversity can also be an important hedge against portfolio risk. Many investment and financial planners continue to stress the importance of having at least some overseas assets in a portfolio. For example, while U.S. stock returns averaged about 9 percent in 2004, returns averaged 18 percent in Hong Kong, 22 percent in Canada and 47 percent in Mexico. The point is not to chase those returns but to think globally.

While a 20 percent overseas allocation is higher than many U.S. investors are comfortable with, Lakatos says she keeps about 40 percent of her personal assets invested in overseas stocks and bonds. "A portfolio that is only domestic is inherently inefficient," she said.

Mike Anderson was until recently executive editor of TheStreet.com. Among the stocks and funds mentioned, he owns ConocoPhillips and ChevronTexaco.