The current investment climate is at a heightened level of risk and uncertainty.  This is, in large measure, a result of the recent, poor relative returns of well-known, larger capitalized stocks.  After an unprecedented five-year winning streak for large-cap growth stocks from 1995 to 1999 (as measured by the S&P/BARRA 500 Growth Index below), a majority of investors simply held on to their positions, and often reinvested their gains in additional shares of these same stocks.  They were enjoying the impressive gains and hoping they would go on forever.   Unfortunately, the experienced turned painful when the bull market ended abruptly in early 2000.  Many investors who did not rebalance their portfolios became increasingly growth-oriented and suffered the most through the decline. 

Investors caught in this momentum trap were not alone.  There have always been periods when certain asset classes or investment styles were in favor, and then quickly dropped from favor.  Below are some recent well-know index returns illustrating this:

Average Annual Calendar Year Index* Returns

In-Favor Yrs.	Stock Index	Annual Return	Tougher Yrs.	Annual Return
1985-88	MSCI EAFE	43.4%	1989-1992	-4.5%
1993-94	MSCI EAFE	19.5%	1995-1997	6.3%
1995-99	S&P/BARRA 500 Growth	35%	2000-2001	-17.5%
2000-3/31/02	Russell 2000 Value	21%	?	?

The flavor-of-the-day is small-cap value.  Beginning in 2000 and carrying through the current year, the Russell 2000 Small Cap Value Index has done well, averaging a 21.0% annual return.  Mid-cap stocks have also shown strong relative performance. By comparison, the S&P 500 Index has generally been in decline since the March 2000 peak.  We could be at only the beginning of a long winning streak for small cap stocks.  Or this shift could reverse tomorrow, after two fantastic years.  It is therefore prudent to review and perhaps rebalance your particular portfolio.  This will ensure that allocations previously determined have not become overweight in any one investment style or class, and help manage undue investment risk. 

Few people have the experience, ability or luck to accurately predict fundamental changes in the market.  Given the sometimes-drastic differences in performance between different asset classes, it is crucial to rebalance your portfolio on a regular basis in order to ensure that it stays in balance. 

The How To's of Rebalancing
Many investors have trouble rebalancing portfolios.  Some ride their winners and ditch their losers, and inadvertently wind up with portfolios that are unbalanced and far riskier than they intended.  Buy-and-hold investors who don't rebalance their portfolios often get into the same predicament.

Rebalancing tax-qualified accounts such as IRAs and pension plans is easier because merely changing the nature of a particular holding does not generate a tax consequence within a tax-qualified account.  Because it's also psychologically easier not to have to sell "winners," I suggest looking to increased cash flow especially to rebalance taxable accounts, rather than triggering taxable events by exchanging shares between asset classes.  In other words, put new cash into an asset class that has fallen in value, or redirect dividend and/or capital gains distributions (that are taxed upon payment anyway, whether taken in shares or cash) from an asset class that has performed well to one that has fallen below the target mix. 

Cash flow, of course, can also go the other way.  A retiree living off of savings might, for example, sell stock shares if that asset class has exceeded her target allocation.  Some investors think that only bonds can be used for income, but selling stocks can often generate the needed income and at potentially lower tax rates. 

Of course, tax consequences should be only part of the rebalancing strategy, and not, as is too often the case, the main determinant.  For instance, many people who were overly concerned about taxes held on to large amounts of stock acquired from their employers, only to see its value plummet during the recent market meltdown.

*All Indices are unmanaged and are not available for direct investment by the public.Past performance is not indicative of future results. The S & P 500 is based on the average performance of the 500 industrial stocks monitored by Standard & Poor's. The Morgan Stanley Capital International (MSCI) Europe, Australia and Far East (EAFE) Index is a broad-based index composed of non U.S. stocks traded on the major exchanges around the globe. The Russell 2000 index measures the performance of 2,000 small-cap stocks.

**Investors should note that diversification does not assure against market loss and that there is no guarantee that a diversified portfolio will outperform a non-diversified portfolio.