Have you reviewed your nest egg yet this year?

Source: Matt Lucht via Flickr

Source: Matt Lucht via Flickr

Today is June 30th, the midpoint of the year. For some of you, today might be the day that you adjust your asset allocation. For those unfamiliar with the term asset allocation, it’s just a fancy sounding term for adjusting how much of your total invested assets (your nest egg) are in each investment bucket. Investment buckets could be as broad as stocks and bonds. They could be more specific, such as domestic stocks vs. international stocks; small cap stocks vs. mid-cap or large-cap stocks.

Index Funds are the way to go

Today, more and more people are investing with index funds. Index funds are passively managed funds which closely track a particular category. For instance, the S&P 500. An S&P 500 index fund will maintain a portfolio of the 500 largest USA-based companies which encompass the S&P 500. Many of these companies are household names. The five largest companies in the S&P 500 are: Apple, Microsoft, ExxonMobil, Johnson & Johnson, and General Electric.

Unlike managed funds which trade frequently, index funds, like the S&P 500 index fund remain essentially unchanged throughout the year except when companies are removed and/or added to the mix. When a company is removed from the S&P 500, the fund manager will sell all shares and buy shares of the newly added company.

I read the news today, oh boy…

So when the stock market reacts to the news of the day, actively managed fund managers may buy or sell components of their as a result of the news. For instance, shares of most publicly traded companies fell considerably yesterday based on the news that Greece would be shutting its banks for a week. Active managers may have bought or sold stocks based on this news, but the index fund manager didn’t react at all; there was no change to his portfolio’s composition based on the Greece news. Some people may have run for the exits and sold their some of their stocks, others may have seen this as an overreaction and bought more. But, as Peter Lynch said (and we mentioned yesterday), “…don’t worry about any of that stuff. I’ve always said if you spend 13 minutes a year on economics, you’ve wasted 10 minutes. … I deal in facts, not forecasting the future…”

As Peter Lynch suggests, you can just spend three minutes a year and adjust your portfolio. It’s quite simple to adjust your asset allocation. The fewer holdings you have, the easier it is. Conversely, the more investments that you have in your portfolio, the more involved your asset allocation is. Regardless, it’s not all that complicated.

Using the most simplistic example of just two two investment options, your adjustment is simple. Let’s suppose you have an allocation of 60% stocks and 40% bonds. If today is the day that you reallocate your portfolio, you would look to see what your current asset allocation is and sell some of the holdings in your investment with the higher allocation and use those proceeds to buy some of the lesser allocation to bring it up to 40%.

So if your stock index fund had increased in value since your last allocation to 70%, you would sell the amount necessary to lower that allocation to  60%. So if your portfolio was current comprised of $70,000 in stocks and $30,000 in bonds, you would sell $10,000 of your stock index fund and use that $10,000 to buy bonds. After the trades, your new asset allocation would have $60,000 in stocks and $40,000 in bonds.

If you had three funds, and your intended allocation was 40% in domestic stocks, and 30% in international stocks and 30% binds, you would adjust (buy or sell as appropriate) proceeds from each of these three holdings to bring the asset allocation back in line. Again, the more funds you hold, the more involved this reallocation can be, but it’s not all that difficult.

When to Adjust?

Some people fine-tune their asset allocation on the first day of the year, some adjust today; the midpoint of the year. Others adjust twice a year. Still others adjust quarterly of even monthly. There is no hard-and-fast rule as to when you should adjust your allocation, just try to stay consistent. If you adjust every year on your birthday, then always adjust on that day. Don’t try to time the market.

Not everyone elects to adjust their portfolios. Some people just let the winners run. It’s hard to argue with that approach when we are six years into a bull market. Some people would be frustrated to have sold some of their stock holdings every year for the past half-decade only to see the stock market continue to climb.

market correction

While the stocks market does increase over time, there are periods where the market gets ahead of itself a bit and a “correction” takes place. A market correction is defined as a 10% decline in stock market loses values over a short period of time. Typically, there’s a correction about once a year; specifically every 357 days. As mentioned, we are over six years into a bull market since the financial and housing crisis in 2008/2009. The chart above sorts the number of days that it had been before a market correction took place.

Today, we are approach 1,000 days since the last correction; the third longest period in history. So history says that we are long overdue for a correction, regardless, you don’t have a crystal ball, you don’t know when it is going to happen. Arguably, it could last another 900 days (as long as it has gone on now) like if did in the roaring 1990’s. You don’t know when it’s going to correct, you shouldn’t try to time the market. If you are an asset allocator and you elect to adjust your portfolio on a regular basis, I strongly suggest that you continue to do that. If you adjust on the last day of the second quarter, like today, do it. If you adjust at the beginning of the year, then adjust on that date.

Whatever your asset allocation adjustment date(s) happen to be, stay the course and stick to your guns. There are plenty of studies which suggest that adjusting your allocation annually will increase your overall, long-term returns. If your are interested, click here, here, here, here, and here. Some of these reports might not only better explain the advantages of rebalancing your portfolio, but they might help your insomnia. 😉




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