The stock market went on a tear in 2012 and 2013, with the S&P 500 up almost 47% in the two-year period.1 This was great news for investors, but a big market gain (or loss) over a relatively short period of time could throw a portfolio out of balance. It might be a good idea to examine your investments to make sure that your asset allocation still reflects your chosen strategy.
Maintaining an Appropriate Mix
Asset allocation — the mix of asset classes such as stocks, bonds, and cash alternatives in a portfolio — is a cornerstone of sound investing. The appropriate mix depends on your personal situation, time frame, and risk tolerance. Typically, investors shift to a more conservative allocation as they near retirement, emphasizing bonds and other fixed-income investments in order to help preserve principal.
When the equity market experiences a big upswing, stocks tend to become overweighted relative to other asset classes. This imbalance can be more extreme when low interest rates suppress bond yields, as was true throughout the 2012–2013 period (see chart).
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In this type of environment, it can be tempting to “let it ride” and continue to watch your portfolio gain in value while stock prices rise. However, history has made it clear that the market is cyclical. When the tide turns, a portfolio imbalance may result in greater losses than you are prepared to absorb. This can be especially risky for investors who have less time to recover from losses.
It takes discipline to rebalance when a “hot” asset class is rising. However, doing so not only may return your portfolio to an appropriate mix, but also could allow you to use gains from one type of asset to buy another type of asset while prices are still relatively low.
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Asset allocation is a method used to help manage investment risk; it does not guarantee a profit or protect against loss. The return and principal value of stocks and bonds fluctuate with market conditions. Stocks, when sold, and bonds redeemed prior to maturity may be worth more or less than their original cost. Investments seeking to achieve higher yields also involve a higher degree of risk.
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1) Yahoo! Finance, 2014 (S&P 500 for the period 12/31/2011 to 12/31/2013)
The information in this article is not intended to be tax or legal advice, and it may not be relied on for the purpose of avoiding any federal tax penalties. You are encouraged to seek tax or legal advice from an independent professional advisor. The content is derived from sources believed to be accurate. Neither the information presented nor any opinion expressed constitutes a solicitation for the purchase or sale of any security. This material was written and prepared by Emerald. © 2014 Emerald Connect, LLC
