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Friday, 04/11/2003

Do you own multiple DRIP accounts: Annual, if not quarterly rebalancing should be pondered for your consideration.
by Steve Gail

I am sure many of you out there are sitting with multiple DRIP accounts or more amply put, multiple companies either being held at sharebuilder.com of a similar custodian that holds multiple DRIP accounts in your name. If you are currently in this situation, a discussion to consider Rebalancing your DRIP positions may have some merit for you. Rebalancing ones DRIP positions should be considered if you own, ideally; anywhere from four (4) of more various DRIP positions and they are held at one location like either sharebuilders.com, equiserve or another similar custodial company. Rebalancing, is the process of making sure that you maintain the same percentage or balance between all the stocks that you have, based on the beginning balance you had with each stock at the beginning of any reviewed period (e.g. quarterly, semi-annually, annually.) To better explain, let's look at a hypothetical example of several DRIPS (or stocks) and how they are rebalanced. For example let's say you decided to start with the following for DRIPS.

1. International Business Machines - IBM
2. Disney - DIS
3. General Motors - GM
4. Dupont - DD

Furthermore, you also decided that you wanted to have your investment allocated in the following dollar and percentages.

IBM $2,500 - 50%
DIS $1,000 - 20%
GM $1,000 - 20%
DD $ 500 - 10%

This breakdown above with the percentages that followed would be initially how you would have allocated your original investment. (of course your percentage breakdown will vary as to how much you wish to allocate into your individual DRIP stocks, based on your own pre-determined risk tolerance. These same percentages should also be used when you consider the amounts you invest from your automatic reinvestment bank accounts and any optional stock purchases you may make periodically.)

Unfortunately, most investors think after they have determined their appropriate allocation for their purchase that this is the end of the process. How wrong they are! Here is the reason why.

For the sake of example, let's say we only REBALANCE ANNUALLY 0r once a year. Here is what happens and why we rebalance. Suppose at the end of the year the four (4) DRIP stocks that we mentioned above, end up with the following balances on your year end statement. (See examples below)(we are also assuming that you made automatic reinvestment add ins as well as optional cash purchases.

EXHIBIT B:

Notice that after all of your automatic investments and optional cash purchases and dividend reinvestments, your year-end statement shows you have a total account value of $10,000.

However, if you look closer you will notice that the percentages of each of your DRIP purchases is different, due to market fluctuation. If you look at IBM and Dupont (DD), you will see that they have the same percentage amount as your original investment, IBM 50% and DD 10%.

However, if you look at the percentages that DISNEY(DIS) and General Motors (GM) make up, you will see that DIS makes up a higher percentage then your original investment and General Motors makes up a lower percentage. (see exhibit below)

EXHIBIT C:

Now in order to keep your original investment in balance, based on your starting percentages and more importantly your risk tolerance, you would have to sell $1,000 dollars of DIS stock to get Disney back to its original purchase percentage of 20%, which would be $2,000 ($3,000 less $1,000) Then in the case of General Motors (GM), you need to purchase $1,000 of additional stock to get GM back to its original percentage based on your original purchase of 20%. ($1,000 plus $1,000). Of course you would take the balance from the sale of the Disney and use those proceeds to pay for the shares of General Motors (GM). In the example below once that is complete your 4 DRIP stocks are now REBALANCED.

After Rebalancing the Portfolio should look like this, Rebalanced

(see below)
EXHIBIT D:

As you can see, with rebalancing you never expose yourself to anymore risk then the percentages that you originally started out with. In addition, when you rebalance, you end up buying more shares of the shares that have not performed well (similar to dollar cost averaging, or averaging down) however; you do this with the profits from your investments that are performing well. Once again the reason that this is advantageous is because you never become more exposed to any one position then you originally were exposed to. This is done by rebalancing and maintaining your original percentages at all times so as not to change your initial risk tolerance.

In addition, you can choose to rebalance your various DRIP stocks any periodic time you choose (e.g. monthly, quarterly, semi-annually or annually). However you need to be sure that you take into consideration issues like, fees, transaction costs, and the additional record keeping that will be required to maintain a record of your cost bias and holding periods. Additionally, be very careful to take into consideration record date and ex-dividend dates, as one does not wish any dividends by acting capriciously.

While rebalancing may not be appropriate for all DRIP investors, as your account grow and you become diversified you will find this practice significant in the overall performance of your portfolio. But remember, to judiciously choice your periods of rebalancing and keep careful records for cost bias and watch those ex-dividend dates.

Until Next Time,

 
 

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