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Investor Education



To appreciate how performance differences can affect an unbalanced portfolio over time, throwing it more and more out of sync with its original allocations, consider what happened to a hypothetical portfolio left unbalanced for the 20 years ended December 31, 2012.

Hypotheical Portfolios

As you can see, the original 70% allocation to U.S. stocks grew to 81.3%, while the other allocations shrank, reducing their intended risk management role in the portfolio. As always, past performance is no guarantee of future results.*

Bonds haven’t been as volatile as stocks over long periods of time, but recent history shows that they too can experience performance patterns that may alter asset allocation over time. Consider the divergence of the stock and bond markets in 2008 and how that affected asset allocations. While the S&P 500 lost 37% during this period, long-term U.S. government bonds gained 23%. A portfolio composed of 50% of each at the start of the year would have shifted to an allocation of 34% stocks and 66% bonds at year’s end.* Without rebalancing, the decline in equity markets during 2008 resulted in allocations far from target, which did not self-correct with the subsequent 2009 rally in equities.

Seeing the Whole Picture
To gain a full appreciation of your investment strategy, go beyond stocks and bonds and calculate the percentages you have in other asset classes, such as cash and real estate. In addition, you may want to evaluate your allocations to categories within an asset class. In equities, for example, you might consider the percentages in foreign and domestic stocks. For the fixed-income portion of your portfolio, you might break your allocation into U.S. Treasuries, municipals, and corporate bonds. If you’re pursuing income from bonds, you may want to know the split among short, medium, and long maturities.

How often should you rebalance? The usual answer is anytime your goals change; otherwise, at least once a year. However, to keep close tabs on your investment plan and make sure it doesn’t drift far from your objectives, you may prefer to set a percentage limit of variance, say 5% on either side of your intended target. Crossing that limit could trigger a review and possible rebalancing.

*Source: Standard & Poor’s. Diversification does not guarantee a profit or protect against risk of loss. Past performance is no guarantee of future results. Results for actual investments will vary. The chart is designed to illustrate divergence from an original asset allocation due to drift induced by return variation over time. It is not intended to promote the performance of any index or actual investment, which may be less than these returns show. It is not possible to invest directly in any index.

Domestic Stocks are represented by the total returns of Standard & Poor’s Composite Index of 500 stocks, an unmanaged index that is generally considered representative of the U.S. Stock Market. Bonds are represented by the total returns of the Barclays Aggregate Bond Index. Money Markets are represented by the total returns of the Barclays 3-Month Treasury Bills index. Foreign is represented by the total returns of the Morgan Stanley Capital International Europe, Australasia, Far East (EAFE®) Index.

© 2011 McGraw-Hill Financial Communications. All rights reserved.