NEW YORK (AFX) - The last time the Dow Jones Industrial Average hit a record high, paper millionaires were being minted, irrational exuberance was in the air, and investors forgot about concepts like rebalancing and asset allocation.
Now, as the Dow Jones Industrial Average returns to those levels six years later, cooler heads prevail. The latest milestone -- on Thursday the Dow, which represents 30 major stocks, closed at a record 11866.69 -- should serve as a trigger to revisit what's hopefully a long-term asset allocation that might need some minor tweaks at most.
'Your portfolio needs to be designed in a manner consistent with your overall financial plan and goals. And if there has been no change in your goals and objectives, and no change in your comfort with risk, then there does not need to be a fundamental change in the risk profile of your portfolio,' says Michael Kitces, director of financial planning with Pinnacle Advisory Group in Columbia, Md. 'That being said, market milestones often prove to be a good reminder to sit down and review your portfolio, and confirm it actually is consistent with your financial plan in the first place.'
First, confirm that your asset allocation -- spreading your money across different slices of the stock and bond markets -- is still on track and based on your current investment goals, time horizon, age, and risk tolerance. Then, you might want to consider rebalancing -- or trimming winning positions and investing back into areas out of vogue -- if your actual asset allocation targets have become out of whack.
'Rebalancing forces us to do what's emotionally uncomfortable but financially productive,' says John Nersesian, wealth management strategist at Nuveen Investments in Chicago. 'It seems counterintuitive to so many investors. They might think, 'The Dow is doing so well, why would I take money from that?'' and put it in laggard investments.
But a portfolio left untouched can change drastically over time. For instance, if you invested 50 percent of your portfolio in stocks and 50 percent in bonds 20 years ago, that would have evolved into a much riskier portfolio today. Because equities outperform fixed income over time, the value of the stock portion of your portfolio would make up 71 percent of your assets, while bonds would be 29 percent, according to Ibbotson Associates, a unit of the Chicago-based Morningstar Inc., that specializes in asset allocation.
There are a variety of theories on how often a strategic investor should rebalance. Some prefer to make changes quarterly because that's most convenient, while others prefer to do it when they stray a certain percentage beyond their target allocation. Other financial planners say they take a more active approach, making changes opportunistically, depending on market and economic conditions. A good rule of thumb, however, is to revisit your portfolio when it strays 20 percent in either direction from your target, says Gobind Daryanani, president of iRebal LLC, a Morristown, N.J., company that conducts rebalancing research and provides automated rebalancing software to companies.
For instance, if you dedicated 30 percent of your portfolio to large-cap stocks, and that grew to 36 percent or shrunk to 24 percent of your portfolio, it might be time to rejigger your holdings and rebalance -- which, over the long term, can help boost returns and lower volatility.
Financial experts also recommend keeping the current move in perspective: One adviser points out that while the Dow may have reached new heights, the Standard & Poor's 500 Index is still about 13 percent off of its spring 2000 high, and the Nasdaq is still about 55 percent from its dot-com bubble levels.
'It's just one index, and it doesn't represent the broad market,' says Robert O'Dell, a financial planner with LVM Capital Management in Wheaton, Ill. 'One of our themes has been to emphasize value -- buying at the right time and (investing in) companies that are paying dividends or increasing dividends.' And, on a short-term basis, Nuveen's Nersesian adds a note of caution: 'It's important to recognize that the market is up 10 percent in the last three months. And the best time to add equity positions is in a period of uncertainty or concern. Investors need to keep this recent move in context.'
'It wasn't that long ago that pundits were saying investors need to abandon traditional stocks and they need to look at more alternative investments like hedge funds,' Nersesian says. 'It's interesting to open the paper and see that the Dow, the stodgy old approach to equities, is at an all-time high, and here are a number of hedge funds that are closing up shop.'
Copyright 2006 Associated Press. All rights reserved. This material may not be published, broadcast, rewritten, or redistributed.