When is Rebalancing Your Portfolio Appropriate?

I'm fortunate enough this year to have enough extra cash on hand to put some more money toward retirement, which will also let me pare down my 2006 tax bill. But I'm having a hard time deciding where to put it.

A few years ago my wife and I saw a financial planner. He suggested asset allocation formulas based on our age, income, etc. Then he suggested how those allocations might change over time. Basically he suggested we go from a riskier portfolio while young to a more conservative one as we get closer to retirement.

We followed his advice at first, but a perhaps predictable thing happened: a couple of our retirement "buckets" did very well, while others languished. Specifically, our riskier small cap funds did very well, while our large cap and international funds did only OK.

As per our financial planner, we should be rebalancing our portfolio over time to try to keep the allocation as close as possible to the percentages we discussed. That would now mean throwing more money at large caps, international, and now the dreaded bond funds in order to balance out how much money we have sitting in small caps.

You probably see where this is going. Why do I want to keep throwing money at the worst performing funds in order to try to craft a less risky portfolio, particularly if the so-called risky funds continue to outperform the "safe" funds. If "safe" means lousy performance, I don't want to keep giving "safe" my money.

The theory of course is that the "risky" funds can go gangbusters for a while and then crash, while the "safe" funds are just that, safe. Lower-producing, but you won't lose your shirt.

There are two schools of thought on this, and maybe the school you're in depends on how risk-tolerant you are. For me, putting twice as much money into "safe" funds and still having less in them than my "risky" funds seems like lunacy.

I need a rebalancing scenario that I can live with, because the one that's been fed to me thus far isn't working for me.

How do you handle this issue? Posted by: Justin McHenry    Source