Dear Professor,  

Jack L.  

You have my sympathy, Jack--2000 was a tough year to debut as an investor. I'm pleased, though, to see that instead of dwelling on your inauspicious start, you're thinking about the big picture. Rebalancing--or restoring your portfolio mix--is an important part of that.  

Read on to learn why rebalancing matters and how you can use Morningstar.com's Portfolio Allocator for explicit directions about how to strike that balance. 

Why Rebalancing Matters 
Rebalancing is important because any mix of investments will get out of whack over time. Your bond funds won't grow at the same rate as your stock funds (nor lose as much), your U.S. and foreign funds will post differing returns, and funds following different investment styles will behave differently from each other, too.  

In 2000, for example, many value funds gained while growth funds lost money. The result? Whatever your mix of funds at the start of the year 2000, it was a very different mix by the end. For example, if you had started the year with a 50/50 split between your value and growth funds, and your value funds gained 15% for the year while your growth funds lost 12%, you would have ended the year with a 57/43 split between value and growth.  

That shifting mix matters. You had a reason for dedicating a certain portion of your portfolio to U.S. stocks, a certain portion to foreign, and so on. You built your portfolio to reflect your investment goals and the level of risk that you're comfortable with. But if your portfolio has drifted far enough away from that original mix, it will no longer be the same fit for you.  

Using Portfolio Allocator 
With 401(k) statement in hand, go to Portfolio Allocator. (Portfolio Allocator is a feature of Morningstar.com's Premium Service, which you can try for free for 30 days.) Then follow these steps:  

1. Choose a portfolio. If you aren't already tracking your investments in Portfolio Manager, you need to enter them. To create a portfolio in Portfolio Manager, click here. Be sure to create a Transaction Portfolio--that will enable you to track how your portfolio changes over time, which is vital for rebalancing.
   
   
2. Next, specify the parameters of your ideal portfolio.
   
   Asset Allocation--Enter how much you want to commit to cash, U.S. stocks, foreign stocks, and bonds. 
   
   Investment Style--Indicate how much you're allocating to large versus small and mid-cap companies and to value versus growth. For blend investments, or those that land in the middle of the Morningstar style box, split the allocation between growth and value. For example, if your ideal portfolio has 20% in large value, 20% in large blend, and 10% in large growth, enter 30% large value and 20% large growth.
   
   Sector Allocation--Indicate how much you want to commit to various sectors of the market, such as utilities or technology. If you don’t think about your portfolio in terms of sectors--most fund investors don’t--opt for the same sector exposure as the broad U.S. stock market. To get those sector weightings, click on "Change Index" and select Wilshire 5000 (an index that tracks the total stock market). Then simply enter the index's sector weightings as your target percentages.
   
   
3. Next, set the bond style for your portfolio. Because bonds serve mostly to stabilize your portfolio, it makes sense to go with middle-of-the-road options. For interest-rate risk, choose moderate risk (five-year duration). For credit quality, choose AAA (very high quality). 
   
   
4. Set some guidelines for which investments Portfolio Allocator should choose from to make its recommendations. Do not select "Allocate" based on Morningstar Fund Analyst Picks. If your 401(k) plan options include few or no picks, this will just confuse the program.
   
   If the portfolio you entered doesn't include all of the fund options your retirement plan offers, enter the rest in Additional Securities. That will make it easier for Portfolio Allocator to tailor your investment options to match your ideal portfolio.
   
   Finally, if company stock is part of your retirement plan, be sure to click the box next to it in the list of portfolio holdings. That way, Portfolio Allocator will take into account the fact that you probably can't reduce the position and switch the assets to funds.
   
   
5. Click "Results." Portfolio Allocator will tell you how much you need to buy or sell of each investment to bring your current portfolio into line with your ideal. 

This column originally ran on January 26, 2001.