In the past, frequently big gains typified the investment market scenery. And, while many individuals may pay attention to the general principles of asset allocation when driving down the road of Individual Retirement Account (IRA) portfolio management, it is understandable that sometimes being broadly diversified may be overlooked. As a result, it may become easier to get swept up in the euphoria of a rising stock market and lose sight of some basic principles of investing.
How you choose to diversify your IRA investments should be based on your personal needs and objectives. Unless your needs and objectives have changed, you may be asking, “Shouldn’t my strategy remain the same?” Yet, after a significant rise in the stock market, you might find the investment mix that makes up your IRA varies considerably from its original composition. Why should this be cause for concern?
Back to Basics
One of the reasons for allocating certain percentages of your investment dollars to specific asset categories is to try to maximize returns for a given level of risk in such a way that meets your investment objectives. The general idea is that when some markets are falling, others are rising. Consequently, you won’t be caught with all your eggs in one basket, leaving you subject to the risks of one specific market.
For example, let’s look at a hypothetical starting portfolio with the following mix: 40% in domestic stocks; 25% in international stocks; 15% in domestic bonds; 10% in international bonds; 5% in real estate; and 5% in cash. Times have been good and the domestic stock market has done well. So well, in fact, that domestic stocks now represent 65% of your portfolio.
But remember, your original portfolio allocated only 40% to domestic stocks. You are now more heavily concentrated in domestic stocks than you planned to be, and you are exposing your portfolio to more market risk than you had intended. Should the domestic stock market experience a downswing, your portfolio will suffer disproportionately, relative to your original allocation.
Some investors evaluate/rebalance their portfolios at regular intervals (e.g., annually), while others take action only when a category percentage has changed by at least a specific amount (e.g., 5%). However, before rebalancing to match your original allocation, you might want to consider some of the factors on which that allocation was based. For example, have your life circumstances or goals changed? Has your time horizon or risk tolerance changed? If so, the original portfolio mix may no longer fit your investment objectives.
Staying on Course
When one segment of the market does exceptionally well, it may be tempting to sit back and put your investments on “cruise control.” However, if you believe in containing risk, there may be times you will need to readjust your course. Otherwise, you’ll be letting changing market conditions dictate your path rather than actively using the market to help you reach your chosen destination.