When it is time to redesign
by William G. Lako, Jr.
December 27, 2013 12:00 AM | 817 views | 0 0 comments | 33 33 recommendations | email to a friend | print
William G. Lako Jr.<br>Business Columnist
William G. Lako Jr.
Business Columnist
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Previously, I discussed rebalancing your portfolio to bring your investments back in line with the allocations you intended after having a year of high returns. It is also necessary to change your portfolios to keep them in line with your financial objectives. When you began investing for retirement, you determined your investment goals, your acceptable level of risk, and the appropriate asset allocation to reach that target. As the years pass, your risk tolerance changes, assets increase and decrease in value, and your portfolio can deviate from your original allocation between equity and fixed-income investments. Your financial goals may also change over the years.

For example, what were appropriate investments for the last 10 years may not be appropriate for the next 10 years. Older investors, who are near their retirement goals, may want to reduce their portfolio’s risk by trimming their equity holdings and increase their holdings of bonds and cash. This may help avoid volatility and could help you preserve the wealth acquired over a lifetime of investing. This process of changing the percentage of assets invested in different asset classes is known as reallocation or redesigning.

With the markets up more than 20 percent for the year, you may consider fulfilling your liquidity needs for the next 10 years. Liquidity needs refer to the difference between your after-tax income and your desired after-tax spending for any given year. This may be for retirement, the purchase of a second home, or for college education. Ideally, you should begin to provide for liquidity needs about 10 years before you need the money. You may do this by selling your stocks and buying fixed-income investments to correspond with your liquidity needs. This can help you avoid selling during a down market to cover liquidity. The money you need for spending should be in investments that are maturing; therefore, you should be able to let your equity investments weather the market volatility.

Ideally 10-year money should be in a 10-year bond; however, in the extremely low interest rate cycle we are experiencing, that is likely a poor decision, because interest rates may rise. When interest rates rise, the price of your bond falls. If you need to sell it before it matures, you will likely lose money. You may consider keeping fixed-income investment maturities short, under three years. The point of having money in fixed-income investments is for capital preservation. When the short-term bonds come due, hopefully, you should be able to reinvest at a higher interest rate.

Redesigning may also be an option for investors in an extreme case where every part of your portfolio has failed to meet your expectations, or when your investments no longer meet your minimum investment criteria. Before you leap into a new investment strategy, you should make sure you are doing it for the right reasons. Generally, you should not choose this strategy based solely on investment performance. Your investing strategy should be consistent with your goals and time horizon. If you were to move most of your money into conservative investments before you need to preserve your principal, you may sacrifice the potential for higher returns.

Redesigning a portfolio should not happen overnight. You may begin by directing new money into new investments that meet your revised investment criteria, while you systematically begin selling underperforming investments and reinvesting the funds elsewhere.
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