FinancialDominance.com

Raise your hand if you think the stock market has been a little volatile lately. It has been a crazy couple of weeks watching the DOW drop by triple digits, bounce back a couple of hundred points in a glimmer of hope, and then drop by several hundred more points the next day. Many investors have found a new friend in anxiety medication. If you have any stock exposure in your portfolio, you’ve probably shared in their pain.

However, many investors may be feeling this pain more than they need to. If you have any exposure to stocks in your portfolio (especially international stocks), you have probably enjoyed a healthy return for the past two or three years. These gains have likely caused stocks to become a more disproportionate part of your portfolio than you had originally anticipated. Thus, during this downturn, you are being negatively affected on a disproportionate portion of your portfolio.

This is where asset allocation comes into play. Asset allocation is the redistribution of investments within a portfolio to meet an investor’s objectives and goals. It explains 90% of the variability of returns in a portfolio.

So, if it is so important, why do many people fail to do it? The main reason is because they hope that what happens in the past will continue to happen in the future. A co-worker told me a couple of weeks ago that, because international stocks have done so well, he has started to transition more of his portfolio into those stocks. In the short run, he may do fine. In the long run, though, he is putting his portfolio at risk by concentrating all his eggs in one basket.

In fact, I would suggest he do the opposite. Let’s say that, during the course of defining his investment goals, he decided to have 60% in domestic equity, 20% in international equity, and 20% in bonds. Now, after international equity has soared through the roof, his mix has become 55% in domestic equity, 25% in international equity, and 20% in bonds. I would suggest he sell off the additional international equity he has acquired and purchase additional domestic equity to rebalance his portfolio. This will allow him to be consistent with the mix of investments he chose after defining his goals.

I recommend you rebalance your portfolio annually if not semiannually. By doing this, your portfolio will continue to reflect your objectives as an investor. You may lose out on gains in the short term, but you will have a steadier return in the long term.

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