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Reallocating Your Portfolio

If you're using an Asset Allocation strategy to meet your investment goals, you need to know your timeframe, your current mix of financial assets, and the level of risk you're comfortable taking. But your goals, timeframes, risk tolerance, and portfolio value change all the time, so your allocation may need to change, too. Knowing when and how to reallocate is just as important as deciding your initial allocation.

When You're Young

When you start investing and your major goals are years (or decades) away, your asset allocation will probably emphasize equity investments. That usually means buying stock, stock mutual funds, and stock exchange-traded funds (ETFs). Equity investments are considered appropriate because they have a history of increasing in value over time and building your net worth.

But if you add buying a home to your list of goals, you might reallocate some of your assets from equities to cash equivalents, like certificate of deposit (CDs). CDs are much less volatile, and less volatility means you're more likely to have the money on hand for a down payment when you need it. In other words, you may not be able to wait it out if the stock market takes a downturn, and there's no guarantee that it will recover if it does.

As You Approach Your Goals

When you come closer to achieving your longer-term goals - for instance, sending a kid to college or retiring - you'll probably want to reallocate more of your money into investments that aren't as vulnerable to volatility as equities are. Your new allocation might increase the percentage of income-producing investments, including dividend-paying equities and bond funds. You might also add investments designed to preserve capital, such as CDs and short-term bond funds.

By moving out of riskier investments, you can help protect what you've accumulated over the years against the risk of a major downturn in the financial markets. On the other hand, you probably don't want to abandon equities. It's important to own investments with growth potential.

When Your Life Changes

Major life events can have a big impact on your financial situation. It will happen, and when it does, you should be proactive about assessing your portfolio, and reallocating if it makes sense to do so.

If you get married:

If you and your spouse have separate investment accounts, take the time to review what each of you already has. Having too much invested in any one asset class could expose you as a couple to too much risk or not enough growth potential. If you see either of those is a possibility, you can decide on the best way to reallocate. You may also want to create a joint investment account to help you reach your shared goals.

One thing to tackle as a couple is whether each separate account should be allocated individually, or whether it makes more sense to take a big-picture approach. With a holistic approach, it might make sense to emphasize one asset class in a single account and another asset class in another account. Neither approach is necessarily better, but you do need a plan. Getting married will impact big things like your overall goals and plans, but also on everyday items like your tax bill.

If you have a baby:

If your goal is to send your child to college, you may want to reallocate a portion of your investment principal to a Coverdell education savings account (ESA) or a college savings plan. You can pay for college from any investment account, but you should consider taking advantage of the tax-free growth that dedicated college savings accounts provide.

If you change careers:

If you find yourself in a new career, you may have more disposable income than you did before (good for you!). That may mean that you can increase the amount you're investing for a particular goal, or you could reallocate your portfolio to add a new asset class. One benefit of having more income to invest is that you are sometimes more comfortable taking on additional investment risk.

If you retire:

Retiring usually means a major reallocation of your portfolio, which you actually may need to do gradually over the ten years or so before you stop working. Generally speaking, approaching retirement means a shift from equity investments to income investments. How you manage that reallocation depends on the asset you've accumulated for retirement.

If you have a fixed income pension rather than a retirement savings plan, you'll probably make different allocation decisions than you would otherwise. Knowing you have a certain amount from the pension each month might make you willing to leave more of your investment portfolio in equities during your early retirement.

The Bottom Line

You can't use the words "right" and "wrong" to describe allocation or reallocation decisions. One thing you can be sure of, though, is that life will change, and so too, should your investment goals and how you plan to reach them. As your needs change, don't ignore your investments. Asset allocation is not a "set it and forget it" strategy for the long term. The way you choose to invest your portfolio at various stages of your life does make a big impact on your financial security.