SAN DIEGO (ETFguide.com) - Imagine designing and building a
beautiful garden. You spend lots of time, money, and sweat making
sure you have the right combination of plants and that they're
correctly juxtaposed to one another. Now imagine never bothering to
maintain that beautiful garden. What a complete waste!
Similarly, people spend time and money trying to build the perfect
investment portfolio. But they overlook the maintenance part. And
that's why periodic rebalancing is a must.
Financial research shows that all asset classes have eventual
price mean-reversions in the long run. That means when an asset
declines enough in price, it is more likely to experience high
subsequent returns.
For example, when corporate bond (NYSEArca: LQD) prices fall and
yields go up, the forward return on corporate bonds increases.
Along similar lines, when the S&P 500 Index (NYSEArca: SPY)
falls in price, its dividend yield increases. And based upon
empirical data, the subsequent returns on the S&P 500 tends to
be significantly above average.
Price mean reversion in asset returns indicates that a
disciplined rebalancing approach in asset allocation should enhance
a portfolio's returns.
When is the ideal time to rebalance? Anytime a portfolio gets
out of whack with its original objective or whenever a substantial
change in asset values makes it necessary.
The objective of rebalancing is to take an investment portfolio
back to its original target asset allocation. And if that original
allocation objective has changed, then rebalancing will realign it
in accordance with the new target.
Besides reducing risk,rebalancing can keep a person's
investments correctly aligned with their investment
goals.
ETFguide's
Portfolio Report Card
is a written report that helps investors to identify strengths and
weakness in their investment portfolios. The Report Card also tells
you whether your investment portfolio has too much risk.
I continue to use this same grading system to evaluate
listener portfolios on my weekly radio program, the
Index Investing Show
, and it works.
Portfolio Lab is a column from ETFguide that focuses on
investment ideas and tools to help individual investors improve
their results.