What to Consider in a Year-End Balancing Check

It’s often a good idea for investors to take a year-end check of their portfolios with an eye on rebalancing their mix of mutual funds. In 1995, with the stock market up so sharply and tax-law changes looming, a December review may be especially wise.

The idea behind rebalancing is to keep your holdings of stock, bond and money-market funds--plus subcategories such as small stocks and international equities--in line with your target percentage mixes. If you strive to keep 60% of your portfolio in stock funds, for example, you might want to cut back if this year’s rally has pushed that to 65% or more.

Rebalancing provides a good excuse to unload some shares in high-flying funds and channel that money into asset categories that have lagged--a natural buy-low, sell-high discipline.

“Taking some chips off the table [at a profit] is one of the keys to investing,” says Douglas Fabian of Fabian Investment Resource newsletter in Huntington Beach. “You don’t want to be doing all of your selling at a bear-market bottom.”

But the rebalancing can be complicated by taxes, transaction fees and other hurdles. Here are some points to guide your thinking:

* How often should you review your portfolio? Some advisors recommend quarterly checkups, but others believe once a year is sufficient.

“The end of the year is a good time because it goes along with New Year’s resolutions,” says Steven Matuszak, executive editor of the Fax on Funds advisory service in Reno, Nev.

But the issue also depends on how much your holdings have fluctuated, because tiny movements aren’t worth bothering with.

“We recommend rebalancing any time your asset allocation varies by 5%, up or down,” says Rob Cummisford, a consultant with Ibbotson Associates in Chicago.

That means if you want to keep 50% of your assets in stock funds but now have 55% because of the market’s rally, it might be time to trim.

*

Whatever ground rules you do decide on, the key with a rebalancing strategy is to stick with it, says Kurt Brouwer of Brouwer & Janachowski, a San Francisco investment firm.

* Can you rebalance without selling shares? Yes, by investing new cash into laggard fund categories or directing dividends or capital-gains distributions from one portfolio to another. This could be a good solution if you own funds with back-end sales charges or redemption fees.

* Might you want to sell laggard funds? Yes, if a portfolio has trailed a relevant market index and rival funds for more than a year and a half or so. But this isn’t so much a portfolio-rebalancing decision as it is a fund-replacement issue--you would still want to maintain a stake in the category.

* Can taxes get in the way? Yes. Even if your asset mix is out of whack, you might not want to sell shares in a fund if it means you would lock in a large capital gain and pay taxes on it.

This is a special concern now that both houses of Congress have passed bills to cut the capital-gains tax rate, says Dee Lee, a certified financial planner at Harvard Financial Educators in Harvard, Mass. She recommends that investors consider deferring their sales to 1996 or until the capital-gains situation is clear.

* What should investors pare back? Funds holding U.S. stocks make prime candidates following this year’s rally, especially those that have loaded up on technology stocks. Fabian and Matuszak both see better values in international funds.

“Right now, it looks like the emerging-markets funds have taken their baths and are coming back,” Matuszak says.

But trimming a stock-fund position might not be prudent for people who established their equity allocations too low in the first place.

One standard rule of thumb is to set your stock-market holdings at a percentage equal to 100 minus your age. But Fabian thinks this measure is too conservative given today’s increasing life expectancies. Long-term investors, including many retirees, require the greater returns possible from stock-market assets to stay ahead of inflation, he says.