The Must-Do Year-End Money Move to Save Your Retirement

David Karp/AP
2013 has been a great year for investors in the stock market, with gains of around 25 percent for the Dow Jones industrials (^DJI) capping off a five-year bull-market rally. Many investors who had the discipline to hold their stocks after the market's plunge during the financial crisis in 2008 and early 2009 have seen their portfolios recover to their pre-crisis levels -- and keep climbing.

But if you want to preserve your investment gains, you need to learn from the mistakes of the past.
Specifically, there's one crucial money move you need to make to realign your portfolio with the appropriate level of risk that you can afford to take with your investments. That move is rebalancing your portfolio.

The Basics of Asset Allocation

Many investors use a method called asset allocation as the basis for their overall investing strategies. Asset allocation involves breaking your portfolio into several pieces, investing each portion in a different type of investment.

Traditionally, investors split their assets across stocks, bonds, and cash, coming up with asset allocations that reflected their relative risk level. Riskier portfolios included higher percentages of stocks, while more conservative investors prefer greater allocations to bonds and cash.
For instance, investors with middle-of-the-road risk tolerance but without any need for a separate cash allocation might choose a 50/50 split between stocks and bonds, giving them growth potential from their stocks and reliable income from their bonds.

Asset allocation strategies are simple and easy to follow, but they require some attention to make sure that they stay in balance.

Over time, different types of investments will produce different returns. If one investment soars in value while another plunges, then you'll quickly find yourself with more of the better-performing asset than you originally intended. That might sound ideal, but it actually creates risk that you might not even know is there until it's too late -- unless you rebalance.

How Investors Got Burned in 2008

We saw the downside of the risk of unbalanced portfolios during the bear market of 2008. Between early 2003 and late 2007, the stock market almost doubled. That was obviously a positive for the value of their investment nest eggs. But an unintended result was that many of those who had neglected rebalancing their portfolios found themselves with much larger allocations to stocks than the target allocations in their personal investing strategies.

When the stock market started to fall, the heightened level of risk in those investors' portfolios became apparent. With stocks falling 37 percent in 2008, even those who had thought they had conservative allocations to stocks found themselves with losses of 20 percent or more. With rebalancing, these investors wouldn't have avoided losses entirely, but they would have reduced their impact and made it easier to recover from the market's collapse.

Will History Repeat?

Since 2009, we've seen an even more dramatic move in stocks, with the S&P 500 (^GSPC) needing to rise less than 10 percent further to triple its worst levels during the bear market five years ago. That has sent stock allocations through the roof for those who haven't rebalanced their portfolios.

Moreover, even for those who are diligent about rebalancing, 2013 has been an extreme year for portfolio balance. During much of the mid-2000s, stocks and bonds rose together, limiting potential imbalances. In 2013, though, bonds have fallen at the same time that stocks have soared, and so even in the space of a single year, a 50/50 portfolio has seen its stock allocation rise as high as 60 percent.

What To Do

Rebalancing your portfolio isn't a complex process. The simplest way to do it is to refer back to your target asset allocations, add up the investments you have in stocks, bonds, cash and other assets, and then run the numbers to figure out where you need to cut back and where you should add to your positions. This year, what you'll likely find is that you're selling stocks at record highs -- just about the perfect answer to follow the mantra of buying low and selling high.

Another method works if you're adding money regularly to your investments. Rather than allocating new savings according to your asset allocation percentages, you can put all of your savings toward whichever type of investment is underweight, helping boost its share of your overall portfolio. Depending on how much savings you have, this method might go too slowly for your comfort, but it's also useful if you don't want to sell investments and generate tax liability.

Whichever way you do it, though, don't skip rebalancing your portfolio this year. With such a strong stock market, failing to see the danger of a future market drop before it's too late could cost you a big portion of the profits you've earned from your investments in recent years.

You can follow Motley Fool contributor Dan Caplinger on Twitter @DanCaplinger or on Google Plus.

Increase your money and finance knowledge from home

Banking Services 101

Understand your bank's services, and how to get the most from them

View Course »

How to Buy a Car

How to get the best deal and buy a car with confidence.

View Course »

Add a Comment

*0 / 3000 Character Maximum


Filter by:

Hey commonsense, you want to blame the democrats for the 17 trillion debt, lets see, 8.5 trillion spent in Iraq, so far 3.5 trillion spent in Afghan. The debt from just these 2 wars will haunt this country for decades to come for we have to help our wounded heros. You forgot all the money bush jr. spent in his 8 years after taking over a surplus. To make his debt look better he took from social security trust fund.

December 30 2013 at 2:40 PM Report abuse -3 rate up rate down Reply
2 replies to toosmart4u's comment

We only blame the Dems for what is their fault. You give them a pass on everything.

December 30 2013 at 4:59 PM Report abuse +3 rate up rate down Reply

still a bush thing

December 31 2013 at 12:00 AM Report abuse +1 rate up rate down Reply

How can you save money for your retirement if you live in a southern red, republican dominated, state with such low wages and benefits?

December 30 2013 at 2:35 PM Report abuse -3 rate up rate down Reply
1 reply to toosmart4u's comment

Do like all libs, go on welfare.

December 30 2013 at 4:59 PM Report abuse +2 rate up rate down Reply

All the social security checks are not the same amount. It is your personal account, the more you pay in the higher your check. Now if you are on social security and medicare thank a democrat, if you want to put an end to these 2 fine programs vote republican.

December 29 2013 at 7:56 PM Report abuse -3 rate up rate down Reply
3 replies to toosmart4u's comment

Instead of complaining about the economy (which I agree has not been robust to date)..invest on a regular basis. Anyone who has done any research should know that the best time to invest in the market is when it is doing very poorly. Those who invested in 2009 have reaped the benefits.
Even now is a good time to invest..averaging into the market over a 12 month period until you reach your allocation goal...for instance (just a an example) 60% equities/40% bonds/ one over age 30 should be 100% in equities (unless they are filthy rich).
However, there will always be those misinformed people who wait till the economy is perfect
before they enter.. Then they get burnt badly and scream the market is rigged and the small retail investor has no chance. Which I agree, the small investor has absolutely no chance if they
wait till that mythical rainbow economy to appear.

December 29 2013 at 11:32 AM Report abuse +2 rate up rate down Reply
1 reply to analyst0042's comment

in retirement, if you have 7 year of expenses tucked away in a safe investment you can be a little more aggressive with securities. a 60% equities, 40% bonds/cash ratio might not be bad if that 40% is enough for 7 years of living expenses. people need to remember that a dollar in 2001 is now worth 42 cents. that puts the market's rise a little more in perspective.

December 30 2013 at 10:41 AM Report abuse rate up rate down Reply

Seems to me that as long as the Federal treasury is pumping 80 billion each month into the economy it will continues to roll on stagnant. I wonder how long it will take for the market to show its true colors after the feds stop propping up Wall Street and the banks? God Bless America because the 1% has controlled the market and taken all the profits made in America.
Oh, by the way our is economy is stale but China is booming thanks to everything we buy made there. Keep it up Americans and we will be a 3rd. world country within the next 3 years.

December 29 2013 at 8:17 AM Report abuse rate up rate down Reply
2 replies to cmyamaha's comment

So do your part in reversing your stated trend and stop buying anything made in China.

December 30 2013 at 6:51 AM Report abuse +8 rate up rate down Reply

2 years at best

December 30 2013 at 11:59 PM Report abuse rate up rate down Reply

Same old stuff...............

December 29 2013 at 6:47 AM Report abuse rate up rate down Reply

I see so all the older people should follow the expression Run For The Hills and move out f the US

December 29 2013 at 6:14 AM Report abuse +2 rate up rate down Reply
1 reply to ferrellfarmer's comment

At least move to an affordable State for Seniors - By moving to the South I save a min of 20%, this is in part do to lesser state income tax, school tax and cheaper prices. Then when you add up expenses for snow removal and burning less gas in the winter, the saving continue. I agree with you.

December 29 2013 at 8:21 AM Report abuse +5 rate up rate down Reply
2 replies to acpward69's comment

I question saving $ from burning less gas for heat, as you\'d spend more $ on air conditioning and dehumidification. Anything made of wood rots faster in the more humid south.

December 30 2013 at 6:55 AM Report abuse -1 rate up rate down

Florida is full.

December 30 2013 at 8:08 PM Report abuse -1 rate up rate down

It's a suckers game meant to steal people's money. Merril Lynch anyone?

December 29 2013 at 3:53 AM Report abuse +2 rate up rate down Reply
1 reply to audioknot1's comment
Andre Paquin

Yep, just keep borrowing to keep up the payment on the moortgage you cant afford. the second SUV, 2 vacations a year, the ATV, the boat, big screen TVs etc, because at the end of the day the government will bail you out when your credit house of cards comes tumbling down.

December 29 2013 at 5:02 AM Report abuse rate up rate down Reply

Hmmm, “the basics of asset allocation” in my opinion is for dummies. Over the past decades stocks and mutual funds have been way up on average compared bonds. Thus, if you had your money in funds, you would be much further ahead than with allocation. Sure, there are time when bonds out perform stock. But, with a little work from your brain tissue, you can tell when to be in stocks or in bonds, but not both. Like right now, who would want to be in bonds when they are on the average down five or more point this year because interest rates on the rise and can't drop further unless they go below zero. Then, you have our feds with the blessing of President Obama dumping money into the banking system like there is no tomorrow. At least for the short term, stocks and funds are the place to park your cash……………

December 28 2013 at 11:50 PM Report abuse +5 rate up rate down Reply
2 replies to barryaclarke's comment

That might be true if you are very young. However if you are in your 50's and a severe recession hits then those in 100% equities will be brutalized and might not recover in time to fund their retirement. Better to be satisfied with lesser gains then bite your nails down to nubs when you are in 100 % equities. That is why beginning to invest on a regular basis (no matter how small at first) is better than waiting until your 40's and are forced to be overly aggressive.
The miracle of compounding will work wonders over a 40 year period.

December 29 2013 at 11:39 AM Report abuse +4 rate up rate down Reply

barry you had better have a plan in place to get out of the market when it starts to fall. it can drop 50% in just a matter of days. i prefer to keep several years of expenses safe for the lean years. but you are right, equities are where it's at TODAY!

December 30 2013 at 10:47 AM Report abuse rate up rate down Reply

I don't think the true tax implications were addressed here.

December 28 2013 at 11:48 PM Report abuse +1 rate up rate down Reply