Retirement Guy. Getting Back Into Balance

Copyright 2009 Consumers Union of U.S., Inc.All Rights Reserved

Consumer Reports Money Adviser

December 2009

SECTION: Pg. 15 Vol. 6 No. 12

LENGTH: 784 words

HEADLINE: RETIREMENT GUY. GETTING BACK INTO BALANCE: Rebalancing your investment portfolio can put you on track for the future.

Now that we can open our financial statements again without requiring smelling salts or a defibrillator, it’s probably time to consider some next steps. One of those steps is rebalancing our investment portfolios, or at least making sure we’re comfortable with how they are currently positioned.

Rebalancing implies, of course, that our portfolios were balanced in the first place. That is, divvied among stocks, bonds, and cash according to our age, risk tolerance, income needs, and other considerations. If you’ve never gotten around to it, that’s fine too. Whether you’re balancing for the first time or rebalancing for the umpteenth, the basic process is the same.

1 Know what you’ve got. First, list all your holdings and what they’re currently worth. Divide them into those three basic categories: stocks, bonds, and cash. “Cash,” you’ll recall, refers to very liquid, short-term investments like money-market mutual funds.

Bear in mind that balanced mutual funds, for example, will straddle categories, investing in both stocks and bonds. If you have a significant amount of money in one, take a moment to go through the fund’s latest paperwork or check online to see how its managers are currently dividing their investments. You can then list each portion in the appropriate category.

Financial planners have different opinions on whether you should count your home as an asset here. I’d say leave it out for now unless you’re planning to sell tomorrow, immediately downsize to a less expensive place, and invest the profit.

If you have a defined-benefit pension and believe it to be safe, you could think of it as a sort of income-producing bond for this exercise. If you aren’t already receiving benefits, you can ask your plan trustee for an estimate of what you’ll have coming once you retire.

2 Make two pie charts. One should represent your ideal asset allocation and the other what you possess now. If you don’t have an allocation already in mind for that first pie, a financial planner can help. If you’d rather do it yourself, Eric Tyson, a financial counselor and author of “Personal Finance for Dummies, 6th edition” (Wiley), says that the familiar rule of subtracting your age from 110 or 120 and putting the resulting percentage in stocks is better than nothing. Whatever’s left can go primarily into bonds and, to a lesser extent, into cash.

Even if you worked out an allocation a year or two ago and were satisfied with it then, you might want to revisit it now. As Edie Barschi, a certified financial planner in Berkeley, Calif., says, your financial needs or risk tolerance may have changed, regardless of whether your portfolio has.

3 Plot your next moves. If pies No. 1 and 2 are substantially different, you have several options. The first and easiest move, if you’re still working and investing for the future, is to use your new contributions. If you want to have a greater percentage in stocks, for example, direct more of your 401(k) money or other investments into stock funds. By the same logic, if you’re retired and gradually drawing down your portfolio, you can start to take more from whatever category of holdings you have too much of.

After that, aim to rebalance as much as you can within your retirement accounts, where you can move money around with no tax impact. If you have to fiddle with nonretirement accounts, be sure to consider the tax basis (that is, what you paid) for any investment you might sell. All else being equal, it’s better to sell things where you’ll have less taxable profit, or a loss that you can use to offset other income.

Barschi points out that you can also “bank” your losses. That is, if rebalancing causes you to rack up greater losses than you are able to use this year, you can use them in future years. This provision, called a capital loss carryover, is explained in IRS Publication 550, “Investment Income and Expenses,” available online at www.irs.gov.

You’ll also do well to consider timing. If you sell investments in nonretirement accounts before the end of this year, you’ll have to deal with the tax consequences come April 15, 2010. If you do it in January or later, you can wait until April 2011. This ignores quarterly estimated taxes, which you may want to look into if you’re going to incur a large tax obligation.

4 Relax until next time. Financial planners I’ve spoken with over the years have had some very different notions of how often one ought to rebalance, ranging from never (in rare cases) to continuously (also rare). Tyson suggests that every three to five years can be often enough, while Barschi suggests reviewing your allocations at least annually.

“But it shouldn’t be every month,” she adds, “or you’d go nuts.”

LOAD-DATE: January 14, 2010