Fall 2008 issue of Horizons

knowledge. commitment. value. CERTIFIED PUBLIC ACCOUNTANTS AND BUSINESS CONSULTANTS

that if an investment has performed well in the past, it should perform well in the future. Unfortunately, past performance is not always a good indication of future results. Many investors, however, remain heavily invested in last year’s winners and diminish or drop last year’s losing asset classes. We saw this in the late ’90s, when a large number of investors focused on large growth stocks and did not rebalance with the shifting market. Therefore, they ended up with a larger percentage of large cap growth stocks than their risk parameters warranted, due to market actions alone. Several even presumed the trend of high performance would continue for an indefinite period and bought more, adding to their already over-weighted technology positions. As the business cycle evolved, the market fell sharply in 2000, causing their equity values to plummet much more than they would have had they rebalanced. Today the same holds true with the recent strong performance of bonds and commodities and real estate before them. Many times the investors’ first indication they have taken on too much risk is when they experience the negative effects of a market downturn. Fear leads either to a rush to sell or, even worse, hold on to losing assets and hope for a rebound. When the sale is finally made, it usually results in a significantly depleted investment value. Those who increased their stock positions during the rise countered conventional thinking by buying high and selling low. Large institutional investors, like pension plans and foundations that manage billions of dollars, have gained crucial insight into the need for regular rebalancing. Most have formal policies on the frequency of rebalancing and investment committees that regularly evaluate their portfolios’ current allocations and decide whether to rebalance. This practice is equally applicable to individual investors as a means to control risk. Regular rebalancinghelps tobringadisciplinedapproach to your investing process. The value of this discipline is demonstrated in a chart created by the Schwab Center for Financial Research, which looks at the risk and return of annually rebalanced portfolios versus portfolios that were stagnant. In most cases, a rebalanced portfolio had lower risk and similar to slightly higher returns. The chart to the right shows the results of a rebalanced portfolio with a moderate risk profile annually from 1970 through 2006.

Source: The Schwab Center for Financial Research with data from Ibbotson Associates Inc.

This practice is successful due to the contrarian nature of rebalancing. In rebalancing, you buy low and sell high. As the business cycle evolves, underperforming asset classes begin to outperform and vice versa. Another approach to rebalancing is from a tax-smart perspective, like using a tax-deferred account to avoid taxable gains. There also is the option of allocating any new savings to the asset class that has dropped. Another choice is to have dividend and capital gain distributions received in cash and reinvest them in under-weighted asset classes. All of these methods can assist you in regaining your target allocations without unwanted fees and/or taxes on your investments. As far as timing, we recommend a quarterly assessment of your portfolio, thinking about reducing any asset class that has surpassed its target by more than 5 percent. There is no set formula for rebalancing. Talk to your financial advisor for assistance with your rebalancing strategy.

Questions? Contact:

Mike Ferman, CPA Partner RubinBrown Advisors 314.290.3211 mike.ferman@rubinbrown.com

8 ◆ fall 2008 issue