Year-end is a great time to take a close look at your finances. Because volatile markets can skew the percentage of stocks, bonds and cash in your portfolio, it’s important to give your portfolio an annual check-up to make sure your allocation remains aligned with your situation and goals.
It’s easy to do in three simple steps:
Step one: Develop a target asset allocation
Given your individual financial circumstances and goals, what percentage of your portfolio should be dedicated to each asset class? For example, if you’re close to retirement, you may want the majority of your portfolio in income investments such as cash and bonds, with a smaller percentage in stocks to protect your portfolio against inflation. If you’re younger, and can tolerate the fluctuations of the stock market over time, you may want to put the majority of your investments in stocks.
Step two: Evaluate your portfolio
Next, determine if your actual investments match your target asset allocation. If they do, your portfolio is in good shape. If they’re off, consider just how far off they are.
Since making frequent changes to your portfolio can have tax consequences, you may only want to alter the asset mix if it’s off by more than five percentage points.
Step three: Rebalance
If your asset allocation has drifted significantly away from your target, you can rebalance your portfolio in a variety of ways.
For example, you can shift funds out of the asset class that exceeds its target into the other investments, or you can simply add funds to the asset class that falls below its target percentage. You can even direct dividends from the asset class that exceeds its target into the ones that are below their targets.
This will bring your portfolio back into balance, but because of tax implications, it’s important to talk to your advisor before making any significant changes to it.