Not doing anything can bring more risk

If you never change your portfolio, over the years you will:

Own an investment mix that is vastly different from the one you selected.


Be betting that tomorrow's markets look a lot like today's.

Did you ever think that doing nothing could mean so much?


The theme here: Once a year, rebalance your portfolio.

Take a look at the asset allocation you decided on when you set up your portfolio and compare it with what you have now. Do you have too much in bonds and too little in stocks? Or is your cash component smaller than what you planned on?

If your investments are out of balance, you buy or sell until the portfolio is back in line with your asset allocation plan.

In the booming stock market of the late 1990s, you could have ignored rebalancing and still looked like a very smart investor.

However, "The problem is, in rising markets you often take on more risk than you're suited to," said Bryan Olson, vice president for investment research at Charles Schwab Corp.

He points out that if, in the beginning of 1994, you had put together a 60 percent stock, 40 percent bond portfolio, and you did nothing for five years, the rising stock market would change all that. At the end of 1999 you'd be 80 percent into stocks and have only 20 percent in bonds.

"Just in time for what, the stock market to turn around and come crashing down?" Olson asked.

So you get smart; you rebalance in 1999 and go back to the 60-40 mix. The bear market pushes stocks down and bonds rise. You again do nothing until the end of 2002. At this point, you're 40 percent into stocks and 60 percent into bonds, just in time for another market turnaround, Olson said - the current rising stock market.


Callan Associates, a San Francisco investment consulting firm, looked at the issue in 2000.

Over the past 30 years, Callan's research - and a similar study by Ibbotson Associates for 1977 through 2002 - found that rebalanced portfolios had virtually the same or slightly higher returns than those that were not rebalanced. They did so, generally, while taking on far less risk.

The picture, it turns out, varies greatly by decade. In the 1970s and 1980s, when markets were choppy, Callan found that rebalanced portfolios had better returns and lower risk.

That's in part because, before 1995, you could not discern a long-term pattern in the market that would have helped you pick the winner. No single asset class was on top for long.

All that changed in 1995, when growth stocks became the clear trend winner. For four years, large growth stocks, the S&P; 500, beat anything else. In the fifth year, it was small growth stocks.

The result: If you had bought and held growth stocks in the 1990s, you would have come out with much better returns than someone who took money off the table, selling growth stocks at their highs and buying, let's say, bonds at their lows.


The never-rebalanced investor, however, would have taken on more risk, as stocks became an ever-larger proportion of the portfolio because they were increasing in value.

Of course, the transaction costs and tax consequences of rebalancing cannot be ignored. They might offset any extra returns that rebalancing delivers.

To keep them to a minimum:

Direct new investments to that part of the portfolio that needs to grow. Don't sell and pay taxes. Just shrink that asset's importance.

Handle all the adjusting you need to do in your tax-deferred portfolio, such as a 401(k) plan or an IRA. You pay no taxes, only transaction costs.