Review and Rebalance

Review and Rebalance

We finally come to step 5. While this step may not seem that important, it is necessary to protect your investment. Reviewing your portfolio involves a couple of steps. First, you want to check the performance of your overall portfolio and then the performance of each individual investment. Obviously, the old adage about letting your profits run and cutting your losses short applies here, but there is more that needs to be done.

One of the major shortcomings of most investment strategies is the idea that you create a mix of stocks and bonds based on some measure of your aversion to risk and then you maintain that mix no matter what happens with the market or the economy in general. What research has found however, is that the stock market goes through various stages or cycles and the overall level of risk in the market rises or drops based on what stage the market is currently in. If you or your financial advisor do not pay attention to these stages, your chance of suffering major loses increases dramatically.

So when you begin your annual (or semi-annual, or monthly) review, you must take into consideration where the market is. A couple of things to consider: Which direction is the overall market moving? And is the market overvalued or undervalued? The first question can be answered simply by looking at a chart of the market. I recommend a chart of the S&P 500 or the Russell 2000. These indexes are based on a larger number of stocks than the Dow Jones Industrial Average. Either the market is moving up, down, or sideways. Next look at the Price/Earnings ratio for the S&P 500. Is it above 17 or below 17? Once you have the answers to those two questions, you are in a much better position to decide how best to invest your money.

If you look at these two factors right now, you will find the market is drifting sideways to a little higher and the P/E ratio is above 17. That indicates that the risk of loss in the stock market is higher than normal. To give you some idea of what that means, Warren Buffet, CEO of Berkshire Hathaway, one of the most successful investment funds of all time, is not buying stocks. He says that stocks are too risky right now. Instead, he has accumulated about $40 Billion in cash.

So where do you put your money when the market is overly risky? Well, any detailed individual help is definitely beyond the scope of this weblog, but areas to look at include inverse market funds, gold and precious metals, natural resources, foreign currency CD’s and real estate. All of these areas are available through mutual funds, certificates of deposit and ETF’s or Exchange Traded Funds. Your allocation should be based on your personal aversion to risk and how close you are to retirement. This is not the type of information you are likely to read about in the Wall Street Journal. Wall Street has a big financial interest in keeping as many people as possible in the stock market. It is a well-known fact that as interest rates rise the market suffers. The Fed has been raising interest rates for over a year and we are now seeing long-term rates creeping up.

As I have stated before, I have no way to predict which way the market is going to go in the coming months, but I do know this; the stock market is a risky place to be right now.