Rebalance your portfolio

By Linda Stern

WASHINGTON (Reuters) - Call it rebalancing, or call it contrarian investing. Smart investors know they should trim back some winners and buy some losers now and again. It's a way to keep a portfolio in balance, and a way to force yourself to sell high and buy low.

"Instead of relying on emotion, you put mathematics to work," says Jerry Miccolis, a financial advisor with Brinton Eaton Wealth Advisors in Morristown, N.J. "This is how a rigorous rebalancing protocol works," he says. Miccolis recently had his clients cut back on commodity-related holdings and add some of the hard-hit financial firms to their portfolios.

That's despite the fact that some pros still are predicting tough times for financial stocks and runaway inflation that could boost commodity prices even further. The key to Miccolis's strategy, and rebalancing (or contrarianism) in general, is the "rigorous...protocol" part of his statement.

In other words, you can't just arbitrarily decide to sell investments that are performing well and buy laggards; you need a plan that protects you from acting on impulse.

Here are some tips for developing a solid plan that can help you capitalize on volatile markets, instead of getting whipsawed by them.

-- First, choose a target mix of investments that works for you. There is an old rule of thumb: Your age subtracted from 120 should equal the percentage of stocks in your portfolio; you can make up the rest with bonds and "cash" equivalents like money market mutual funds and bank account deposits. But that formula may not be aggressive enough, or detailed enough for most investors. Here's a better alternative: The Iowa Public Employees Retirement System has a calculator on its website that enables you to adjust your target mix on the basis of age, risk tolerance, economic outlook, tax bracket and wealth.

-- Slice and dice further. Don't just target a percentage for stocks, divide it into growth and income stocks, foreign stocks, big and small companies and so on. You can choose big, index-based investments, such as mutual funds and exchange traded funds, for each of those categories.

-- Rebalance often to catch market moves. Gobind Daryanani, with TD Ameritrade, is an expert who created professional rebalancing software and has spent much of his career on this issue. He advocates bi-weekly rebalancing. Whenever a category goes 20 percent above or below its target level, Daryanani tells investors to adjust. Many other experts advise clients to rebalance quarterly or annually. Doing that can help protect your portfolio from getting seriously out of balance, but it won't help you catch big short-term moves.

-- Consider the costs before you make your moves. You can rebalance easily in a tax-deferred account held with a low-cost discount broker; there's no tax consequence and the transaction costs are low. In a taxable account, you have to be more careful: selling winners frequently will set you up to pay lots of capital gains taxes and they may not even meet the one-year holding period required for long-term capital gains taxes. Instead of trading frequently, you can use new investments to buy in your low category. And sell disappointing investments to offset the gains you'll pick up by selling shares of big winners.

-- Play sectors, if you want to. You can have a fine investing life without ever choosing between metals and financials, just hold onto those broad index funds. But if you'd like to pick your own stocks and sectors, target those percentages too. You can use this sector tracker to see which parts of the economy have been growing and which have been ailing. This site monitors select Sector SPDRs -- exchange traded funds that divide the Standard & Poor's 500 stock index into nine sectors -- but can be used to monitor entire sectors. For example, in the last year, the financial SPDR has gone down 28.28 percent, while the energy SPDR has risen 26.73 percent. If you know that you always want to have some of both of those categories, you might surmise that it's time to lighten up on energy and start buying into the financials. If you're always buying what everyone else is selling, and selling what the market is buying, you'll do very well over the long term.

(Linda Stern is a freelance writer. Any opinions in the column are solely those of Ms. Stern. You can e-mail her at lindastern@aol.com.)