Rebalancing Your Portfolio

With the market downturn, does it make sense to rebalance my portfolio?

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The decline in the markets is prompting many of us to ask whether we are comfortable with how much of our money is invested in equities, which are shares of individual corporations that you can purchase separately or through mutual funds. The answer to how much of your money should be in equities depends on many things, including your age, your career situation and how comfortable you are handling the periodic ups and downs in the market and variable annuities.

In assembling a portfolio, most investors should aim for a mix that includes equities, fixed-income investments (which can be bonds or other investments that pay interest), real estate and cash. All four of these are types of "asset classes." No one can eliminate or control what the market does, but every investor can control how much he owns of each asset class, which will help determine how volatile the overall portfolio can be.

In building a diversified portfolio, you should choose which assets you will include and what percentage of your money will go to each asset. However, you should check back regularly and determine whether your allocation has shifted and needs to be rebalanced. This can be done by either selling an asset that now makes up more of your portfolio than you originally planned, or buying an asset that has fallen in value and now makes up less of your portfolio than you prefer.

Let's look at some examples. During a "bull market," or one in which the prices of stocks rise faster than historical averages, the following happens:

Your original asset allocation was made up of 60 percent stocks, 30 percent bonds, 5 percent real estate and 5 percent cash. After the increase in the value of the stocks in the portfolio, your portfolio has shifted to where 67 percent of your money is in stocks, with just 23 percent in bonds, 6 percent in real estate and 4 percent in cash. As a result, your portfolio has a greater percentage invested in stocks, which makes it riskier and less diversified than you originally planned.

The problem can also occur during a bear market, which is a period of declining stock prices:

Your original asset allocation consisted of 60 percent stocks, 30 percent bonds, 5 percent real estate and 5 percent cash. After the price of stocks decline, your portfolio makeup is now 51 percent stocks, 37 percent bonds, 6 percent real estate and 6 percent cash. You now own more bonds than you originally planned and have less money in stocks.

The assets of TIAA-CREF provide another example of diversification across a variety of asset types. All of TIAA-CREF's assets under management declined 17% in 2008 to $363 billion from a year earlier. However, the CREF Accounts, which are fully invested in the markets, experienced a greater impact from volatility, declining 34.4% during 2008, based on total assets under management for the combined accounts. 

A key benefit of rebalancing is that it prompts you to buy assets when their prices are low, making it easier to "buy low, sell high" than trying to predict which way the market is going in the future.

Though it may feel uncomfortable to buy stocks after their price has fallen, doing so means you can reap greater gains if prices rebound in the future. Remember that significant stock market declines have generally been followed by recoveries. If your time horizon is several years out and you can sleep at night with market volatility, it might be a good time to consider rebalancing if the percentage of equities in portfolio is lower than what you planned. Usually rebalancing once a year will suffice, unless you experience a significant life event such as the birth of a child or the loss of a job, or your tolerance for risk changes.

There are also tools on tiaa-cref.org that can help you here. They include an asset allocation calculator and a retirement goal evaluator.

Let our advisors help walk you through building a portfolio allocation that suits you, or rebalancing an existing account. If you are uncomfortable with the market risk exposure in your current portfolio, let TIAA-CREF help you understand what changes to your portfolio would mean as it relates to your overall retirement plan or goals. You can schedule an appointment by clicking here or calling 888 842-0318.