A Publication of WTVP

When it comes to maintaining an appropriate mix of retirement investments, Americans appear to be fooling themselves.

In a recent AllianceBernstein Investment Research study, 77 percent of investors interviewed said they did a good or excellent job of spreading their retirement assets across different types of investments and industries. However, at the same time many of those investors, including business owners and executives, said they don’t regularly rebalance their portfolios. In other words, they don’t routinely maintain their planned mix of stocks, bonds, and cash, which can grow at different rates and throw an asset allocation out of balance. According to the study, 57 percent of investors said they rebalance their retirement funds only occasionally, and three in 10 noted they never rebalance.

“Virtually all high-net-worth investors understand the concept of asset allocation, and those people usually start out with well-diversified portfolios,” said Brent Cardwell, a regional board member for the CFA Institute, an investment training and education provider in Charlottesville, Va. “Where things start to get out of line, however, is when those same people don’t take a regular look at rebalancing their retirement assets.”

Keeping things on target.
Portfolio rebalancing is important because it helps preserve an investor’s asset-allocation targets. High-net-worth investors and others set these targets in line with their risk tolerance, retirement horizon, and other financial goals.

Consider the following oversimplified example: assume you invested 60 percent of your $100,000 retirement portfolio in a U.S. stock index fund and 40 percent in an emerging-market stock fund. In 2005, the Standard & Poor’s 500 index notched a return of about 4.8 percent. Most emerging-market investments delivered returns of 20 to 30 percent. During those 12 months, your asset allocation—absent any additional contributions—easily could’ve shifted from 60/40 to about 55/45. Over time, additional market swings could further shift the original mix of your retirement holdings.

Market performance isn’t the only way a portfolio can move out of balance. Experts say business owners and executives often tend to weight their personal assets too high in their own company’s stock, which greatly increases portfolio risk if an unexpected business downturn occurs. One recent study found that 25 percent of 401(k) participants polled directed at least half of their retirement dollars to company stock. Experts typically recommend holding no more than 10 percent of your portfolio in company stock.

Another way for a retirement plan to tip out of balance is when investors misunderstand so-called “lifestyle funds.” These accounts, which most major mutual-fund companies sell, are designed to match an investor’s age and risk tolerance with a single, well-diversified account. In one type of lifestyle fund, the fund manager rebalances slowly over the years to lessen equity exposure as the investor nears retirement. Another type of fund has more static allocation, so investors need to change funds if they want to invest more conservatively. Some lifestyle-fund investors also invest in other stocks, bonds, cash, or commodities—and therefore risk undoing the balance these types of accounts offer.

Annual return isn’t the whole story.
Most high-net-worth investors can tell their friends how well their retirement portfolio performs against the market. But without consistent rebalancing, Cardwell says those people may be losing ground unknowingly. Here’s how:

During a 10-year period, assume that one investor’s retirement portfolio earns a 5 percent average annual return. However, in four of those 10 years, the portfolio loses value. Now, consider a second investor who takes time to rebalance a portfolio each year. Even if that person records the same average annual return, regular rebalancing would greatly reduce the odds that the portfolio would lose money in any one year. At the end of the decade, it’s likely the second portfolio would have a higher dollar value, largely because it didn’t have to recover from losses. Of course, the value of either portfolio at any point in time could be higher or lower, depending on investment performance.

“By rebalancing, that second investor would minimize downside risk while maximizing their opportunity for greater returns,” Cardwell says. “If you do that each year, even if the return in another portfolio is identical, the overall dollar growth will be significantly higher.”

Is it time for you to rebalance your retirement assets? If so, experts suggest the following steps.

Take a quick refresher on asset allocation. Even if you had professional assistance designing a retirement portfolio, see if you understand where your money is invested today. Be sure you’re comfortable with the risk-return profile and that any costs associated with your investment are reasonable. If the allocation no longer fits your goals, lifestyle, or retirement horizon, talk with a qualified wealth management professional to help you get back on track.

Review your retirement allocations annually. Unlike nonqualified taxable accounts, where rebalancing can create redemption or capital-gains headaches, timing isn’t a major factor in buy-sell decisions for retirement accounts. Since the late 1990s, when so-called “market-timers” sought to cash in on the technology boom, mutual-fund companies have restricted the number of trades investors can annually make between retirement accounts. For high-net-worth investors with a sound asset-allocation plan, an annual portfolio review will likely keep things in balance. However, keep in mind that frequent rebalancing can trigger unnecessary transaction costs.

Take professional advice. As markets swing and regulations change, investors may find it difficult to see hidden pitfalls in their approach. By working with professional advisors, you can tap into a wealth of industry experience and training, and remove much of the stress involved in managing your self-directed retirement accounts.

Investors in the driver’s seat.
Investment experts traditionally have referred to the “three-legged stool” of retirement income: pensions, Social Security, and personal savings. However, all three legs have cracked, leaving investors more responsible than ever for managing their retirement assets. Many employers have terminated traditional pensions, and some pensions have fallen into financial distress or even have been handed over to the federal Pension Benefit Guaranty Corp., which reported a $23 billion shortfall at the end of 2005. Meanwhile, Social Security’s prospects are dimming. A recent report indicated the fund would be insolvent by 2040, one year sooner than previously thought. And Americans’ personal savings rate last year fell below zero—meaning we spent more than we earned—for the first time since the Great Depression.

Faced with these rickety legs, investors’ interest in appropriately allocating their retirement assets has never been greater. IBI