REBALANCE WITH CASH — NOT BONDS — BEFORE YEAR END $TLT

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Rebalancing between bonds and cash at year-end is quite common. Traditionally some practitioners have suggested a higher proportion of bonds as an investor ages. A split of 60% for stocks and 40% for bonds is quite popular.

In a year like 2013 when stocks have been up strongly, to maintain the desired split between stocks and bonds, stocks will have to be sold and bonds added at the end of the year.

This year, I recommend against this traditional rebalancing in favor of bonds. The reason is that bonds are likely at the end of a long bull market. Going forward interest rates are likely to rise. When interest rates rises, bonds generate capital losses.

Take a look at the annotated chart of iShares 20+ Year Treasury Bond TLT .

Please click here to see the annotated chart.

From its peak until now, TLT has already generated capital losses of about 20%. If long-term interest rates rise to the same level as the high if 2011, TLT will generate an additional capital loss of 18.5% as shown on the chart.

All bonds are not created equal. There are bonds of different maturities and different credit qualities. But in every case the point is the same, capital losses can easily exceed the interest received.

Rebalancing is a good idea because it reduces volatility in the portfolio, but this year the rebalancing should be in favor of cash, not bonds…Read more at MarketWatch

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