Nonprofit leaders are encouraging organizations to plan for the future by creating a reserve fund. Once you start building your reserve fund, you'll need to put it somewhere. And just like individual investors, nonprofits need to keep an eye on what their investments are doing. Here are some options for managing your organization's portfolio. Note: This article is provided for information only and is not intended to serve as financial or investment advice. Consult a financial professional for advice specific to your situation.
You probably already know you need to monitor your investment portfolio and update it periodically. Even if you've chosen an asset allocation, market forces may quickly begin to tweak it. For example, if stock prices go up, you may eventually find yourself with a greater percentage of stocks in your portfolio than you want. If stock prices go down, you might worry that you won't be able to reach your financial goals. The same is true for bonds and other investments.
Do you have a strategy for dealing with those changes? You'll probably want to take a look at your individual investments, but you'll also want to think about your asset allocation. Just like your initial investing strategy, your game plan for fine-tuning your portfolio periodically should reflect your organization's investing strategy.
The simplest choice is to set it and forget it—to make no changes and let whatever happens happen. If you've allocated wisely and chosen good investments, you could simply sit back and do nothing. But even if you're happy with your overall returns and tell yourself, "If it's not broken, don't fix it," remember that circumstances change over time. Those changes, especially if they're unexpected, may affect how well your investments match your goals. At a minimum, you should periodically review the reasons for your initial choices to make sure they're still valid.
To bring your asset allocation back to the original percentages you set for each type of investment, you'll need to do something that may feel counterintuitive: Sell some of what's working well and use that money to buy investments in other sectors that now represent less of your portfolio. Typically, you'd buy enough to bring your percentages back into alignment. This keeps what's called a "constant weighting" of the relative types of investments.
Let's look at a hypothetical illustration. If stocks have risen, a portfolio that originally included only 50 percent in stocks might now have 70 percent in equities (i.e., stocks). Rebalancing would involve selling some of the stock and using the proceeds to buy enough of other asset classes to bring the percentage of stocks in the portfolio back to 50. The same would be true if stocks have dropped and now represent less of your portfolio than they should; to rebalance, you would invest in stocks until they once again reach an appropriate percentage of your portfolio. This example doesn't represent actual returns; it merely demonstrates how rebalancing works. Maintaining those relative percentages not only reminds you to take profits when a given asset class is doing well but it also keeps your portfolio in line with your organization's original risk tolerance.
When should you do this? One common rule of thumb is to rebalance your portfolio whenever one type of investment gets more than a certain percentage out of line—say, 5 percent to 10 percent. You could also set a regular date. For example, many people prefer tax time or the end of the year. To stick to this strategy, you'll need to be comfortable with the fact that investing is cyclical and all investments generally go up and down in value from time to time.
You could adjust your mix of investments to focus on what you think will do well in the future, or to cut back on what isn't working. Unless you have an infallible crystal ball, it's a trickier strategy than constant weighting. Even if you know when to cut back on or get out of one type of investment, are you sure you'll know when to go back in?
You could also attempt some combination of strategies. For example, you could maintain your current asset allocation strategy with part of your portfolio. With another portion, you could try to take advantage of short-term opportunities, or test specific areas that you and your financial professional think might benefit from a more active investing approach. By monitoring your portfolio, you can always return to your original allocation.
Another possibility is to set a bottom line for your portfolio: a minimum dollar amount below which it cannot fall. If you want to explore actively managed or aggressive investments, you can do so—as long as your overall portfolio stays above your bottom line. If the portfolio's value begins to drop toward that figure, you would switch to very conservative investments that protect that baseline amount. If you want to try unfamiliar asset classes and you've got a financial cushion, this strategy allows allocation shifts while helping to protect your core portfolio.
Don't forget that too-frequent rebalancing can have adverse tax consequences for taxable accounts. Since you'll be paying capital gains taxes if you sell a stock that has appreciated, you'll want to check on whether you've held it for at least one year. If not, you may want to consider whether the benefits of selling immediately will outweigh the higher tax rate you'll pay on short-term gains. In taxable accounts, you can avoid or minimize taxes in another way. Instead of selling your portfolio winners, simply invest additional money in asset classes that have been outpaced by others. Doing so can return your portfolio to its original mix.
You'll also want to think about transaction costs; make sure any changes you're contemplating are cost-effective. No matter what your strategy, work with your financial professional to keep your portfolio on track.
Daniel Rufo, Rufo Financial Group© 2011, Daniel Rufo
Daniel Rufo is managing principal of the Rufo Financial Group. He has over 24 years of experience assisting in financial strategy construction for nonprofit organizations, foundations, and other institutional clients. He was senior vice president at Citigroup Global Markets for over half a decade, where he was a member of the President's Council. Before joining Citigroup, he served as managing director at MJ Whitman Inc., and as cofounder of Capital Advisors Group.
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