A Policy That Saves You From Yourself

Investment policies work, but only if you follow though. Rebalance when any of your allocations falls 5 percent out of line. Do it automatically, without second-guessing the discipline. If you stop to ask whether stocks will fall (or rise) some more, your long-term plan is toast.

In tax-deferred accounts, rebalancing is easy. You simply shift the money around. Some 401(k) plans have a button on your online account that says "rebalance." Click, and it's done.

In taxable accounts, rebalancing takes longer. You don't want to keep taking profits and paying taxes on your capital gains. Instead, put all your new investments into the asset that underperformed. Keep adding money until you're back in balance again.

"Policy" investors usually keep their money in mutual funds, not actively managed funds, where gains and losses depend on the manager as well as the market. They choose index funds or exchange-traded funds that mimic the market, to keep their asset classes clear. All of the research on asset allocation has been done using market indexes.

Rebalancing becomes difficult when you own individual stocks. In theory, you'd sell stocks that represent popular industries and therefore might be overpriced -- energy, for example. But it may not be clear which industries those are. You might wind up selling a stock that's reasonably priced and keeping a high-flier that brims with risk. You also don't want to be moving money in and out of individual bonds.

Index mutual funds, by the way, aren't investments on training wheels, as Wall Street propaganda would have you think. Increasingly, institutions are using index funds or exchange-traded funds as their core investments, rebalancing as they go. The risk reduction they get from this approach frees them to make more speculative bets on hedge funds, commodities, currencies and individual country funds.

That's a good model for you to follow, too. Index and rebalance your serious money. Set aside 5 percent of your investment pot for a "hobby" portfolio, where you play your hunches and try to prove that you're smarter than the global market that's bidding against you. Who knows? Maybe you are.

If you're rebalancing now, you'd be buying the S&P and selling bonds. Investment policies give you a strategy -- just what you need, in times like these.

Jane Bryant Quinn, author of "Smart and Simple Financial Strategies for Busy People," is a Bloomberg News columnist.