'Rebalance' - that's what the market is telling us

MOST PEOPLE look for buy or sell signals in the market.

Right now, the market's big flashing sign says "rebalance."


To see it, you have to look at the confluence of movements in the stock and bond markets, and relate them to your own portfolio.

And then you have to avoid panicking.


"Most people tend to over-react based on their guess of where the market is headed, without ever figuring out what move would be appropriate based on their asset allocation," says Marc O'Brien of O'Brien Management Inc. in Cambridge, Mass. "They need to invest based on their plan, rather than their comfort level."

Investors have been seeking their comfort level in recent weeks, as bond funds have been getting pounded while stock funds continue a solid rally.

The average taxable bond fund lost 2.5 percent in July, the worst month for bond funds in 16 years, according to Lipper Inc. The average Treasury, government securities and corporate bond funds did even worse.

Meanwhile, the average stock fund was up by 3 percent.

That disparity represented a tipping point for many investors. Nervous that rates will hold steady or keep rising - which diminishes the return of bond funds - investors have been selling out.

Looking for someplace promising to put that cash, they're eyeing stock funds.

While conventional wisdom suggests that a dump-what's-cold-to-buy-what's-hot strategy is a poor idea, few investment experts argue against rebalancing, which typically involves trimming winners and putting the take into the parts of a portfolio that have been lagging.

"People who practiced asset allocation with discipline during the last few years have been rewarded for it, while those people who made big bets and let their portfolio swing wound up hurting themselves," says Mark Balasa of Balasa, Dinverno, Foltz & Hoffman in Schaumburg, Ill. "There's a fine line between chasing performance and rebalancing, but people should be trying to walk it now."


Rebalancing is best done infrequently, with some studies suggesting that once every two years is sufficient. If a portfolio has moved 10 percent or more from its planned allocation, the time is right.

To see how that happens, consider an investor who entered 2001 with a 50-50 planned split between stocks and bonds. If his bond holdings gained 5 percent per year and their stock portfolio lost 15 percent each year, he entered 2003 with 60 percent of his money in bonds and just 40 percent in stocks.

Rebalancing at the beginning of the year - before stocks rallied and bonds started to fall - would have been fortuitous, but completing the task now is still better than letting the market move the portfolio back into place, something it usually does through excruciating losses.

The good news is that rebalancing right now may feel more comfortable than it has in the past.

In 1999, for example, rebalancing a portfolio meant moving out of big gainers such as tech stocks and into laggards. Today, it means moving from bonds - which are already losing steam - to stocks, which have been on the upswing.

The actual rebalancing process is simple. Divide your holdings into asset types - stocks, bonds, cash or money market securities - and measure your current asset weights against your plan.


If your strategy called for 30 percent of your holdings to be in bonds but you find yourself with 40 percent of your assets there, cull your bond issues and redistribute the proceeds so that your portfolio again meets its targets.

Alternatively, let your winners ride, but redirect new investments into the skinny asset classes in the portfolio, thereby moving back toward your targets over time.

Rebalancing reduces the overall risk of your portfolio by spreading the money more evenly between different assets.

There are drawbacks to rebalancing, beyond the potential to turn it into an ill-conceived market-timing move. There may be taxes to worry about, and the costs involved in fund switching - especially in funds with front- or back-end sales charges - can be prohibitive. Before moving your money, decide if these costs for risk aversion are too great, and gauge whether you feel in control as your investment picture starts to drift.

Says Marc Collier of Wellesley Financial: "The best time to make the change was probably a few months ago, before bonds started to fall and stocks had such a good run. But that doesn't mean this is a bad time to refinance.

"The one thing we learned for sure over the last three-plus years is that asset allocation works if you have a good plan and stick with it. It's hard to do sometimes, like in 1999 when everyone was screaming about selling stocks and buying bonds. But this is a time when it should be easy on the emotions and worth doing before it's too late."


Chuck Jaffe is senior columnist for CBS Marketwatch. He can be reached at or Box 70, Cohasset, MA 02025-0070.