Getting Somewhere on Stock Treadmill
Ian McDonald
Sep 5, 2006
The nation's 47 million or so 401(k)-plan investors can hardly be blamed for feeling like they are plodding on a treadmill.
Stocks rang up a double-digit gain in 2003, but over the past five years, the Dow Jones Industrial Average has posted a 2.7% average annual gain. Things may not change soon. When the 1982-to-1999 bull run started, interest rates were sky-high and stock valuations were low. Today we have the opposite.
Frustration can lead many to toss account statements in a drawer and let their portfolios hibernate. At the same time, it isn't a good idea to get in touch with your inner trader-self.
Luckily, sometimes the soundest approach is the simplest. That might be plain-old rebalancing. The strategy -- employed quarterly or annually -- involves using new investments, or exchanges among mutual funds, to keep your exposure to stocks, bonds and cash within a chosen range. Due to tax consequences, it is easiest to do in a tax-deferred account such as a 401(k) or IRA.
Rebalancing can keep you out of trouble. Instead of being lured by the siren song of hot funds, a rebalancing investor automatically puts more money into categories that have shrunk in value and less into those that have swollen. "In this environment I believe in rebalancing instead of buying and holding," says Steve Henningsen , a financial adviser with Wealth Conservancy in Boulder, Colo. "Buy and hold works if stocks are going to rise steadily for several years, but that's not likely."
Consider two portfolios with $100,000 and the same allocation -- 60% in U.S. stocks, 30% in U.S. bonds and 10% in cash -- at the end of 1995. If one portfolio was rebalanced at the end of each year, when allocations were at least five percentage points off target, it would have grown to nearly $228,000 at the start of this month, compared with less than $215,000 for the un-rebalanced portfolio, according to data from T. Rowe Price Group. And the rebalanced portfolio got there with lower risk. From March 31, 2000 through 2002, it lost less than $39,000, while the other portfolio gave up more than $68,000.
Many 401(k)-plan operators offer automatic rebalancing, but most participants don't bother. What is it they say about leading people to water?
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