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posted: 7/17/2011 6:07 AM

Seven tips for reblancing your fund portfolio

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Associated Press

BOSTON -- Summer is generally a calm season for the financial markets. It offers time to reflect, check your mutual fund portfolio, and see whether you're on track with savings goals.

Yet the summer doldrums haven't arrived. There's been no letup in the stock market volatility that set in during the spring. Bond investors wonder when interest rates will make their inevitable rise, cutting into returns. A debt default is still possible in Greece. It could happen in the U.S., too, if Congress and President Obama fail to raise the government's debt ceiling.

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For pros and do-it-yourselfers alike, it's a tough environment for restoring an appropriate balance of stocks and bonds in a portfolio.

Starmont Asset Management CEO Harvey Rowen is playing it safe. Normally the San Francisco-based firm quickly reinvests any cash it pulls out of investments, putting it back into other stocks or bonds. But last month, the manager of more than $100 million for wealthy investors began keeping that cash on the sidelines. It will stay in a money-market mutual fund until a deal is reached on lifting the debt ceiling.

"It's earning basically zero, but zero is better than minus 20 percent," says Rowen, who expects stock and bond prices could plunge if there's no deal before an Aug. 2 deadline.

Rowen sent his clients a letter last week, explaining why he's holding on to more cash. His advice: Expect volatile markets as pre-deadline drama builds.

Despite all the uncertainty, there's no excuse for inaction. Financial pros advise performing a portfolio checkup at least once or twice a year, typically at year-end or midsummer, or both.

Periodically tweaking the mix of stocks, bonds and any alternative assets, such as gold, is essential to avoid taking on too much risk or becoming too conservative. You can also stay on track by taking a close look at any investments in recently hot segments of the market. Top performers may now make up a bigger piece of your portfolio than you're comfortable with. So it may be time to move that money elsewhere.

"People tend to want to invest more in the part of their portfolio that has performed the best, when in reality the better practice is to do just the opposite," says Christine Benz, personal finance director with fund tracker Morningstar.

Below are seven portfolio checkup tips, including special considerations for the current market environment:

1. Create a plan

Determine your appropriate asset mix. For example, an investor expecting to retire around 2025 might set a target of about 70 percent in stocks and 30 percent in bonds. That's just a rule of thumb, as individual circumstances vary. Consider how much you've saved, and how much stock market volatility you're willing to endure. If you're retired, you'll probably want to reduce risk and maintain a regular income stream by emphasizing bonds. If you're younger, be bolder and emphasize stocks.

2. See where you stand

To assess your asset mix, examine all of your investments as a whole -- 401(k)s, individual retirement accounts, and any individual stocks you may own. Don't overlook any accounts you may still have with former employers. Once you've added everything up and broken down the asset mix, see how far you may have strayed from your target asset allocation percentages. Rebalancing may be in order if you're 5 percentage points or more above or below your targets -- say if your target is an 85 percent stock allocation, and you're at 80 percent.

3. Dive deep to diversify

You may not need to go beyond assessing the overall mix of stocks, bonds and alternative investments, and making any adjustments. But a more thorough review can pay off. Examine your investments within each asset category, with an eye toward diversification. That means investing broadly across the stock and bond markets, rather than focusing on a few segments.

Investors may be surprised to learn they're less diversified than they thought, after they see how many of their investments overlap across their accounts. One tool to help uncover trouble spots is Morningstar's Instant X-Ray. It's available on Morningstar's website, under the `Tools' tab. The tool breaks down total investments by asset category, and highlights market segments where an investor may be over- or under-exposed. It can also show whether multiple mutual funds in an investor's portfolio count the same company's stock among their top holdings.

4. Consider doing nothing

If a portfolio checkup doesn't reveal any big variations from your savings goals, it may not make sense to make any adjustments. Potential pitfalls of making too many moves include unintended transaction costs and tax penalties.

5. Limit interest rate risk

Bond investors face substantial long-term risk from an inevitable rise in short-term interest rates, currently near zero. When the Federal Reserve raises rates, prices for bonds with locked-in rates will drop. That's because investors will be able to buy newly issued bonds paying higher interest. Why invest $1,000 in bonds yielding 3 percent if you can get 6 percent for the same price?

When rates rise, investment returns will decline at bond mutual funds, which continually buy new bonds to replace those that have matured. Bonds with maturity dates of 15 years or longer are more vulnerable to rising rates because their investors are stuck with those below-market yields for longer periods than those holding medium- or short-term bonds.

6. Consider what's hot, what's not

Stocks of small companies have performed unusually well in recent years. Funds that specialize in small-cap stocks have returned an average of more than 9 percent a year over the latest 3-year-period, versus less than 4 percent for large-cap funds. That's why small-cap stocks deserve special scrutiny to ensure they don't make up a disproportionate share of your portfolio. The most widely used benchmark of small-cap stocks, the Russell 2000 index, represents about 8 percent of the stock market's overall value. That's a good threshold for measuring your portfolio's small-cap weighting. Market segments that have been hot this year and deserve special attention include health care stocks, and real estate investment trusts. Funds specializing in health care stocks have returned an average 16 percent year-to-date, and REIT funds 12 percent. Stocks of big banks have fared poorly, financial services funds have lost an average 3 percent -- which could present a buying opportunity.

7. Stay flexible

Maintaining a small portion of a portfolio in cash investments such as money-market funds can provide cushion from a stock market decline. That's why Rowen, the money manager who's warning his clients about volatility, is building up his firm's cash stash until politicians agree on a debt ceiling deal. Citing similar fears, Cliff Caplan, a financial planner and president of Neponset Valley Financial Partners in Norwood, Mass., is considering increasing holdings in gold. He's not alone. Investors on Thursday bid gold prices up to an all-time high of $1,589 an ounce -- not adjusted for inflation -- partly due to fears about the U.S. debt ceiling debate.

"It's all about risk management," Caplan says, "because we live in precarious times."

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