Rebalancing your portfolio is just as important as having the right asset allocation. If you've been holding commodities or commodity-related stocks, now may be the time to take profits and refocus on assets that are lagging. It's not a matter of market timing for investors, but rather a strategy built on trimming winners and rebalancing to take advantage of the discounted laggards. (For more information o keeping your portfolio efficient, read our related article Rebalance Your Portfolio To Stay On Track.)

Identify Recent Winners
Investments in energy have handily outperformed the overall market in 2008. The PowerShares Oil ETF (AMEX:DBO) and the PowerShares Energy (AMEX:DBE) are both up over 40% since the beginning of the year. DBO holds oil futures contracts while DBE is a more diversified holding nearly equal holdings of heating, crude, and gasoline futures contracts. Whether driven by speculation or accurate demand expectations both ETFs have benefited from oil futures prices rising above $145 in July. (To learn more about futures contracts, read The Barnyard Basics Of Derivatives.)

The Pullback
Oils strong upward momentum set the stage for its recent pullback near $130 dollars per barrel. Since market timing is nearly impossible, investors may be better off establishing rebalancing routines either by performance or time to trim portfolio winners.

Reallocating by Performance
Let's say you have a 15% return goal in mind for your investment. Once the 15% threshold is reached an investor could simply sell shares equal to the amount of money gained over the initial investment and reallocate the funds to faltering asset. This strategy allows the investor to continue to benefit from the initial investment position, purchase falling assets at a discount, while offering protection from a reversal in the form of profits generated from the investment gain. Retirement accounts like an IRA or a 401(k) are the best places for this strategy in terms of minimizing your tax liability from capital gains. (To learn how to minimize the impact of capital-gains tax, see A Long-Term Mindset Meets Dreaded Capital-Gains Tax.)

Reallocating by Time
An investor could make a commitment to review and rebalance his or her portfolio on a quarterly, semi-annual or an annual basis. For example, an investor with a medium risk tolerance may have composed a 50% stock, 40% fixed income and 10% natural resources (energy) portfolio in January. On a semi-annual schedule, once June arrives if the energy positions have grown to become larger than a 10% portion of the entire portfolio, shares of energy positions would be sold and the earnings would be reallocated to the stock and fixed income buckets. This strategy allows time to dictate when to rebalance rather than performance and can often be setup when opening your investment account.

The TDAX Independence 2040 (AMEX:TDV) and the TDAX Independence 2010 (AMEX:TDD) are two relatively small target-date ETFs that employ the reallocation by time principle to help investors underlying investments take on less risk as they approach retirement. (To learn more about target-date funds, check out The Pros And Cons Of Life-Cycle Funds.)

Conclusion
Rebalancing is a great way for investors to stay in tune with overall market activity and improve returns by capturing gains and reinvesting in laggards. If rebalancing is not for you, know that mutual funds and now ETFs are available to do the job for you.

Related Articles
  1. Mutual Funds & ETFs

    ETF Analysis: Vanguard Total World Stock

    Learn about the Vanguard Total World Stock exchange-traded fund, which invests in stocks located in numerous countries with a high level of diversification.
  2. Mutual Funds & ETFs

    ETF Analysis: iShares MSCI USA Minimum Volatility

    Learn about the iShares MSCI USA Minimum Volatility exchange-traded fund, which invests in low-volatility equities traded on the U.S. stock market.
  3. Mutual Funds & ETFs

    ETF Analysis: BioShares Biotechnology Products

    Learn more about the BioShares Biotechnology Products fund, an exchange-traded fund that is focused on producers of FDA-approved drugs.
  4. Mutual Funds & ETFs

    ETF Analysis: SPDR EURO STOXX 50

    Learn about FEZ, the Euro Stoxx 50 ETF. FEZ tracks the 50 largest companies in Europe, making it the Dow Jones Industrial Average of Europe.
  5. Mutual Funds & ETFs

    ETF Analysis: ProShares UltraShort Nasdaq Biotech

    Learn more about an innovative inverse-leveraged sector exchange-traded fund, or ETF, the ProShares UltraShort Nasdaq Biotechnology fund.
  6. Chart Advisor

    Value Stocks Offer Stability in a Volatile Market

    With volatility on the rise, investors are turning to segments of strength such as value stocks. We'll take a look at several ETFs that could be worth a closer look.
  7. Retirement

    Strategies for a Worry-Free Retirement

    Worried about retirement? Here are several strategies to greatly reduce the chance your nest egg will end up depleted.
  8. Professionals

    Your 401(k): How to Handle Market Volatility

    An in-depth look at how manage to 401(k) assets during times of market volatility.
  9. Stock Analysis

    Should You Follow Millionaires into This Sector?

    Millionaire investors—and those who follow them—should take another look at the current economic situation before making any more investment decisions.
  10. Professionals

    What to do During a Market Correction

    The market has corrected...now what? Here's what you should consider rather than panicking.
RELATED TERMS
  1. Exchange-Traded Fund (ETF)

    A security that tracks an index, a commodity or a basket of assets ...
  2. Qualified Longevity Annuity Contract

    A Qualified Longevity Annuity Contract (QLAC) is a deferred annuity ...
  3. Inverse Transaction

    A transaction that can cancel out a forward contract that has ...
  4. Best To Deliver

    The security that is delivered by the short position holder in ...
  5. Exchange-Traded Mutual Funds (ETMF)

    Investopedia explains the definition of exchange-traded mutual ...
  6. Exchange Traded Derivative

    A financial instrument whose value is based on the value of another ...
RELATED FAQS
  1. Why are IRA, Roth IRAs and 401(k) contributions limited?

    Contributions to IRA, Roth IRA, 401(k) and other retirement savings plans are limited by the IRS to prevent the very wealthy ... Read Full Answer >>
  2. What are the best ways to use your 401(k) without a penalty?

    The best way to use your 401(k) retirement savings account is to take normal distributions after you reach retirement age. ... Read Full Answer >>
  3. Can I take my 401(k) in a lump sum?

    Establishing a retirement savings plan during your working years is a necessary part of comprehensive financial planning. ... Read Full Answer >>
  4. Can I use my 401(k) to pay for my college loans?

    If you are over 59.5, or separate from your plan-sponsoring employer after age 55, you are free to use your 401(k) to pay ... Read Full Answer >>
  5. Can I take my 401(k) to buy a house?

    Once you reach 59.5, you can use the funds in your 401(k) retirement savings account to buy a house or any other expense ... Read Full Answer >>
  6. Can my company ever be entitled to take my 401(k)?

    Depending on the terms of your 401(k) plan, your employer may be able to retain some, or all, of the contributions it has ... Read Full Answer >>

You May Also Like

COMPANIES IN THIS ARTICLE
Trading Center
×

You are using adblocking software

Want access to all of Investopedia? Add us to your “whitelist”
so you'll never miss a feature!