Sharon L. Thornton, The Daily Record Newswire
Investing in a retirement account is not a onetime decision; it is a work in progress over your lifetime. A decision is made to invest money in a certain way at one point in time, but as time moves forward, the “balancing” of that account also becomes important.
What is meant by keeping an account in balance or re-balancing? Balance is understanding, accepting and controlling risk. Risk is most commonly controlled by diversification of the asset mix of a portfolio.
A diverse retirement account may consist of a mix of stocks and bonds. Even within these broad categories there are subcategories of investment. Included in the equity portion of your account would be domestic equities (large, mid and small caps) along with international equities. On the bond side of your account there could be short-term and long-term bonds, corporate, government issues, loan participation funds, international bonds and various other fixed income instruments.
By owning a mix of types of assets in your retirement account, you are diversifying the risk of a particular investment type. Sometimes bonds may perform better than stocks or stocks better than bonds. The exact moment an individual allocates their retirement funds to an investment mix in their account reflects the risk that they are willing to accept on their investments at that time.
Over time, the “balance” of their accounts will change due to investment performance and changes in the risk profiles of the investments contained in their account. It is important to understand these concepts to bring an account into an acceptable balance.
Asset allocation is affected by the strengths of two forces, the performance of each asset type and the addition of funds added to the account over time. The investor has no influence over the performance of each asset class; however they have direct influence over which category additional funds will be added to.
An example would be a typical 50 percent stocks and 50 percent bonds portfolio. In a time period where stocks outperform bonds the allocation will shift and for example becomes 57 percent in stocks and 43 percent in bonds. The overall risk of the account has now shifted from the original intention of allocation. Rebalancing would need to occur to return to the original allocation of assets if there has been no change in the acceptable level of risk.
Another reason to rebalance a portfolio would be the change in risk profile. This would include the risk associated as the individual reaches retirement and is now dependent upon the income from this account to meet living expenses. When they were younger, the investor may have been able to accept more risk in the accumulation phase of life.
What is the most efficient way to rebalance the portfolio? It can be done one of two ways. Funds can be reallocated from one investment to another. This option is the best choice if you have ignored the allocation over a period of time yet may be disruptive to the portfolio.
The second option for rebalancing would be to add new contributions to categories where needed to bring the portfolio back to the original asset mix. Under-funded assets classes are now provided with more money over time. This is a theory of constant rebalancing.
The level of acceptable risk for each investment portfolio will change over time. If you ignore your asset allocation, you may be taking more risk than you can accept.
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Sharon L. Thornton is senior director of investments for Karpus Investment Management, an independent, registered investment advisor that manages assets for individuals, corporations and trustees. Offices are located at 183 Sully’s Trail, Pittsford, N.Y. 14534; phone (585) 586-4680.
