Let Your Portfolio Work for You

Let Your Portfolio Work for You

Article provided courtesy of Katie McAuliffe, Financial Advisor,

Wells Fargo Advisors, LLC in Leesburg, VA

Let Your Portfolio Work for You

It takes time and effort to build an investment strategy that fits your goals. But several factors can disrupt even the best-crafted plan. The simple day-to-day movements of the financial markets can pose a real threat to the health of your portfolio.

Here’s why: As stock and bond markets fluctuate, your asset allocation — the mixture of stocks, bonds and short-term cash investments in your portfolio — can also change. If the markets’ moves are left unchecked, your portfolio’s investment mix can deviate significantly from its original allocation. “That portfolio can end up taking on risk characteristics very different from those you originally established,” says Ty Morgan, senior vice president and director of mutual fund advisory programs at Wells Fargo Advisors. “Rebalancing your portfolio is one of the most important decisions you can make to control risk and volatility.”

Why Rebalance?

During the recent stock market downturn, many investors got a fast education on the importance of rebalancing. In 2008, based on the return of indices, stock values plunged 37 percent while intermediate-term bonds gained 13 percent. Hypothetical investors who started the year with a 60/40 split between stocks and bonds would have seen their portfolio end 2008 with an asset allocation of 46 percent stocks and 54 percent bonds — nearly the inverse of the original allocation.

And if they hadn’t brought their investment mix back in line with the target allocation, a smaller portion of the hypothetical portfolio would have benefited from the stock market’s strong performance in 2009, when equities gained nearly 27 percent. “In 2008, everyone wanted out of the market,” Morgan says, “which meant most of them were still sitting on the sidelines — and missing stock exposure — when the equity markets rebounded in 2009.”

In addition to keeping your asset allocation on target (and your exposure to the potential for gains), rebalancing can help reduce risk in your portfolio (and your exposure to the potential for losses). Periodic rebalancing may help reduce the chance that your portfolio will be too heavily exposed to one particular asset class, so moves affecting that asset class are less likely to have an outsize effect on your overall portfolio. What’s more, rebalancing may help you invest more efficiently by focusing your investments on asset classes that have fallen in value. As Morgan notes, “It’s a strategy that forces investors to buy low.”

How It’s Done

Rebalancing tends to take one of two forms. One is to sell asset classes that have ballooned beyond their initial price target, and to then invest the proceeds in asset classes that have drifted below their target allocation over time. The other is to simply direct any new contributions to areas of your portfolio that have fallen below their targets.

The first strategy may be a good choice for tax-advantaged accounts such as 401(k)s and IRAs because selling investments won’t trigger any capital gains taxes. In a taxable account, however, the taxes you generate may eat into your portfolio’s returns. In such cases, you may want to use new contributions to restore your portfolio’s asset allocation.

You may find that manually adjusting your investment mix on a regular basis — Morgan says most investors should rebalance once a year — requires more effort than you have time for. If so, consider taking advantage of automatic rebalancing, which is typically available for some types of managed accounts. You can choose to have your portfolio’s asset allocation rebalanced annually or even quarterly.

Whether you decide to rebalance your portfolio manually or automatically, Morgan says, the key is to have a disciplined approach to keeping your asset allocation on target. “This is a strategy that can help you strip emotion from the decision-making process,” he says. “Taking a systematic approach instead of constantly tinkering with your portfolio can help lead to long-term success.”

Asset allocation cannot eliminate the risk of fluctuating prices and uncertain returns.

**********

This article was written for Wells Fargo Advisors and is provided courtesy of Katie McAuliffe, Financial Advisor in Leesburg, VA at 703-777-3803.

Investments in securities and insurance products are: NOT FDIC-INSURED/NOT BANK-GUARANTEED/MAY LOSE VALUE

Wells Fargo Advisors, LLC, Member SIPC, is a registered broker-dealer and a separate non-bank affiliate of Wells Fargo & Company.

©2012 Wells Fargo Advisors, LLC.  All rights reserved.                 1212-01444 [90325-v1] 12/12