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Help in Maintaining a Rebalancing ActBy Jane Bryant Quinn
Sunday, June 9 1996; Page H02
The Baltimore mutual fund group T. Rowe Price Associates Inc. is so convinced that individual investors will want to use this strategy that it recently introduced an automatic rebalancing service for its individual retirement accounts.
So what is rebalancing? It's the handmaiden of asset allocation, which is today's most popular investment approach.
When you allocate your assets, you don't buy stocks and bonds (or stock funds and bond funds) in random amounts. Instead, you decide what percentage of your financial investments should stay in stocks and what percentage in bonds. That's called an "allocation."
You own stocks for growth and bonds for reducing the size of your losses when the stock market falls. The classic, conservative pension fund allocation is 60 percent stocks and 40 percent bonds. But portfolios don't stand still. They change as the market does -- and that's where rebalancing comes in.
Say that, on Jan. 1, 1995, you started out with 60 percent stocks and 40 percent bonds. Stocks soared last year. By Dec. 31, they'd have risen to 63.4 percent of your portfolio, leaving 36.6 percent for bonds.
But a portfolio containing 63 percent stocks is slightly riskier than one with only 60 percent stocks. It would drop more in value when the stock market falls.
Asset allocators don't like to change the level of stock-market risk they take. If a 60/40 mix of stocks and bonds was right for you last year, it's probably right for you this year.
So you'd "rebalance" your portfolio, bringing it back to its original 60/40 split. That means selling some stocks and reinvesting the money in bonds.
If the stock market falls, and the value of your stocks drops to less than 60 percent of your portfolio, you'd sell some bonds and reinvest the proceeds in stocks. With this approach, you always maintain the same level of market risk. You're never further out on a limb than you intended.
This strategy also can help your investment returns. You're always selling investments when prices are high and recycling the proceeds into investments whose prices are low. Sometimes (not always) rebalancing yields better results than buying stocks and bonds and holding on to them.
Rebalancing is especially prudent in nosebleed stock markets like the one we have today. When stocks drop, they could come down hard. If they amount to a higher-than-normal percentage of your assets, you'll have a higher-than-normal loss. By rebalancing, you reduce your stock market risk by putting the money somewhere else.
I've illustrated this strategy with a 60/40 mix of stocks and bonds. But it applies equally to any other allocation of assets.
Three things about rebalancing:
It works best with mutual funds -- especially no-load funds, which don't levy sales charges when you buy and sell. It's much more awkward to try to rebalance with individual stocks and bonds.
It works best in tax-deferred retirement accounts. You probably won't want to rebalance in accounts where you're taxed on the profits each year. Paying taxes reduces your long-term return.
It works best when you don't try to "time" the market. Some people change their stock allocation on a guess that the market will rise or fall. But it's almost impossible to time a market right. True rebalancers buy and sell only to hold their risk level steady.
T. Rowe Price's new service is free to anyone with at least $25,000 invested in its mutual funds. You pick the balance you want among your mutual funds; once a quarter, T. Rowe Price will buy and sell shares to restore the balance you started with. Investors who work with financial planners or stockbrokers typically pay around 1 percent to 1.75 percent to have the adviser automatically allocate their assets for them.
If you're rebalancing by yourself, once a quarter is probably too often, because your investment mix won't have changed enough. If your mix is 60/40 and it goes to 63/37, that's not enough to worry about, says Talbot Daley, director of fund marketing for the Baltimore brokerage firm Legg Mason Wood Walker Inc. Rebalancing once a year might be enough -- and even then, only if your portfolio is out of whack by 10 percent or more.