by Bruce Helmer

The gyrations of the stock market in recent months have people wondering what they should do with their investments. Buy, sell, or just hold and wait out the volatility?
 
This first thing to do is put away the stock pages of the newspaper and be sure that you have an investment strategy. Without a strategy, picking individual stocks can be a bit like playing the lottery.
 
The key to a sound investment strategy is asset allocation. Asset allocation simply refers to which types of investments you choose. It groups similar types of investments into broad categories: government or corporate bonds, foreign or domestic stocks, growth stocks or value stocks, stocks of larger or smaller companies, etc.
 
Economists have determined that proper asset allocation can enhance expected performance and reduce risk. It is the dominant factor in determining total portfolio return over time, more important even than individual stock selection or market timing.
 
A portfolio isn’t just a collection of investments, any more than a house is just a collection of rooms. Owning assets without proper allocation is like buying a house with two dining rooms and four living rooms, but no kitchen. Instead, most people say, “I need four bedrooms, a kitchen, two baths, and a living room, and here’s how big I’d like them to be.” Now you’ve got a functional house that meets your needs; you’ve allocated space.
 
A portfolio is your allocation of investment space according to your needs. Instead of doing it by rooms, you do it by percentages of your resources in asset classes: 50% in this type of asset, 40% in that, 10% in another.
 
If you fill your portfolio with assets that perform alike, you could do well if market conditions favor those assets. But if any of those assets performs badly, they probably will all go into the tank. A smarter option is to balance asset classes. Even if one asset class tends to be risky, meaning it can fluctuate wildly, we can balance that asset class with another that tends to move in the opposite direction. That balance reduces risk and increases returns over time. That’s an example of negative correlation — which is positive in asset allocation.
 
Unfortunately, once you’ve allocated assets, your work isn’t over. You still have to manage your portfolio continuously. Instead of a “buy and hold” strategy, I recommend regular rebalancing of your portfolio. If you buy and hold, investments that have done well become a larger percentage of your portfolio and throw your asset allocation out of whack. If you’ve planned properly, you’ve invested in stocks, bonds or mutual funds that provide you with the asset allocation you want. If your strategy hasn’t changed, wouldn’t it still make sense to follow that strategy after a year?
 
Here’s how rebalancing works. Let’s say a mutual fund you own was originally 10% of your portfolio, but because it performed much better than other investments, after a year it is 15% of your portfolio. Rebalancing means that you would sell some shares of that fund and invest them in your asset classes that may have declined as an overall percentage of your portfolio. You buy or sell shares to get your portfolio back to your desired asset allocation.
 
Asset allocation helps you avoid emotional investing, getting too excited about the money you’re making or missing, which can cause you to abandon your strategy and chase whatever stocks are hot. Chasing hot stocks usually ensures that you buy them when they are expensive. The benefit of rebalancing is that you maintain the asset allocation strategy you created and, over time, you have a better chance to buy low and sell high.
 
How often you rebalance depends on whether the investment is taxable or not, the amount invested, your time horizon, and your investment objective. I usually rebalance my clients’ portfolios, and my own, every six months.
 
 
You will certainly be tempted, as we all are, to try to pick the next hot stock. Avoid that temptation — at least until you have developed a sound investment strategy. The real danger of stock picking is that it turns most people into emotional investors. It encourages us to look first at products instead of strategies — and for most people that places their financial futures in jeopardy.

Wealth Enhancement Group
www.wealthenhancement.com
1-800-492-1222