Allocation and Rebalancing

Allocation and Rebalancing — Investing starts with dividing your money into categories


Allocation and Rebalancing — Investing starts with dividing your money into categories

A big part of your retirement strategy should be building and managing your investments. Where you invest your savings, including how much you put into each major investment category, is the factor that may have the most impact on your long-term investment returns. That’s your asset allocation.

Giving your portfolio a little class

Asset allocation is the percentage of money you direct into each of the major asset classes—stocks, bonds and cash accounts. Stocks can be further divided into sub-asset classes such as large cap, mid-cap and small cap, and domestic and international, to name a few. Bonds have sub-asset classes too, including long-term government bonds and corporate bonds.1

Each of these asset classes has a different level of investment risk. Stocks generally have higher risk with higher potential returns. Cash accounts have the lowest risk and returns, with bonds somewhere in between. How you divide your retirement savings among them—your asset allocation—determines your overall risk and return potential, even more directly than the individual investments you choose within each asset class.

The size of each of your investments may change over time
Rebalancing your investment mix over time can help keep your retirement portfolio on track with your goals.

Keeping your balance

Historically, stocks have offered higher returns than bonds over long periods of time. So with 30 years or more before retirement, an investor looking for the most growth potential might have an asset allocation of 90 percent stocks and 10 percent bonds. An investor nearing retirement probably wants to limit risk, and may have an asset allocation of 50 percent stocks, 40 percent bonds and 10 percent cash.2

Whatever allocation you decide is right for you, over the short term, you’ll want to keep your portfolio at your target allocation percentages. But as certain asset classes perform well and others lag behind, your allocation will change.

Let’s say stocks perform better than bonds, and your 90/10 allocation becomes 95/5. That’s when you need to rebalance to get back to your original percentages. In this case, it means decreasing your stock investments by five percent and redirecting that money into bonds. If you don’t rebalance regularly, your risk level changes and your long-term goals could be affected.3

Select an asset allocation then keep it steady by rebalancing regularly.

In general, it’s a good idea to rebalance your portfolio at least every 12 months. This discipline helps you keep your asset allocation on track. It also helps you keep to the old adage “buy low, sell high.” When you rebalance, you are selling your higher-priced investments (which currently account for a larger percentage of your overall allocation) and buying more of your lower priced investments (which account for a smaller percentage of your overall allocation).

Some employer retirement plans and Individual Retirement Accounts (IRAs) offer automatic rebalancing, which makes it easier to stay on target. Target date funds also offer automatic rebalancing as part of their simple, hands-off approach.

Stick to your strategy

Select an asset allocation that aligns with your long-term goals, time horizon and risk tolerance. Then, keep it steady by rebalancing regularly. As your needs and risk tolerance change, make adjustments to your allocation and continue to rebalance to stay in control.

1Stocks are more volatile than bonds, and portfolios with a higher concentration of stocks are more likely to experience greater fluctuations in value than portfolios with a higher concentration in bonds. Foreign stocks and small and midcap stocks may be more volatile than large cap stocks. Investing in bonds also entails credit risk and interest rate risk. Generally investors with longer timeframes can consider assuming more risk in their investment portfolio.

2 These allocation examples are hypothetical and are not meant as investment advice. Your allocation needs may be very different and are based on your goals, time horizon and risk tolerance.

3 Rebalancing does not ensure a profit or protect against loss in a declining market.