COVER STORY

Appropriate allocations to stocks and bonds give you the best chance of achieving your financial goals.

An essential action toward reaching your financial objectives is to establish a mixture of stocks, bonds, and short-term investments that are in line with your goal's time horizon and your own risk tolerance. An equally important step—one often overlooked—is ensuring that your asset allocation stays in balance through the inevitable shifts in the financial markets and as your time horizon shortens. Overlooking your drifting allocation can overexpose your savings to inflation or market risks. "Holding too much of any asset class compromises your ability to reach your goals," says Stuart Ritter, CFP^®, a senior financial planner with T. Rowe Price. "Performing a review at least annually of your asset allocation, and rebalancing when needed, will help you stay on track as the financial markets shift over time."

CHANGING MARKETS, CHANGING ASSET ALLOCATIONS
A properly constructed portfolio provides a balance of risk and return potential that reflects your personal circumstances. An asset allocation that is appropriate for your goal's time horizon—the amount of time until you use your savings—provides the balance of risk management and long-term return potential that gives you the greatest likelihood of achieving your financial goals.

But financial markets are dynamic—they change continually, and their shifts cause your portfolio to change as well. Markets can move due to a wide range of factors, from corporate earnings and economic conditions to government policies and weather-related events. When specific areas of the financial markets post gains or losses, that performance is reflected in your portfolio. If you do not monitor your allocations, the financial markets can cause the balance to shift—sometimes significantly. Says Ritter, "You need to pay attention to changes in your portfolio—and take care not to let it get too far from your target allocation."

THE BENEFITS OF REBALANCING
The key to managing these constant shifts in the market and subsequently in your portfolio is to adopt a periodic rebalancing strategy: Reduce your exposure to asset classes after they have become an overly large percentage of your portfolio and boost exposure to asset classes after they have become too small a percentage of your portfolio.

To understand how allocations can shift over time, consider a hypothetical $100,000 portfolio allocated across 60% stocks, 30% bonds, and 10% short-term investments on January 1, 2008. By the end of the especially volatile year that followed, fixed income and short-term investments would have represented much larger portions of your portfolio than you had originally intended. At the same time, equities would have accounted for a substantially smaller portion of your 60% target. As a result, your portfolio may have had significantly less long-term growth potential than it had a year earlier. The "Volatility and Your Portfolio" sidebar shows the changes in your allocation and value of your assets in each category.

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