When it comes to investing your money, focus on creating and maintaining the mix of stocks and bonds that's right for you. Jupiterimages—www.jupiterimages.com

Investing: When to 'Take Money off the Table'

Updated: Jun 06, 2014 8:23 PM UTC | Originally published: Sep 12, 2012

I think I get the idea of "taking money off the table" when it comes to investments. What I don't understand is when you should do it and how much. Any advice? -- Mark Tyner, New York, N.Y.

You hear this expression a lot around the investing world, usually when people are worried about a possible market setback.

For example, I recently saw a money manager on TV tell viewers it was time to "take some money off the table" because he thought that the stock market, which had gained roughly 10% the previous three months alone, was getting too pricey.

But like many concepts that pass for wisdom in the investing world -- dollar-cost averaging being a prime example -- this one doesn't hold up very well when you really think about it.

Let's say that you "take some money off the table" by selling $10,000 worth of stock from your investment portfolio. Unless you actually spend the proceeds of that sale on living expenses or whatever, you now have $10,000 in cash that has to go somewhere.

Whether you decide to put it in bonds, real estate, commodities, gold or an FDIC-insured savings account, it's still part of your portfolio -- and the return you earn or don't earn on that money still counts as part of your portfolio's overall performance.

So you haven't really taken anything "off the table." All you've done is move $10,000 to a different place on the table.

I don't make this distinction to be coy or to engage in semantics. I do so because the phrase "taking money off the table" creates the false impression that it's okay to view different parts of your portfolio in isolation.

But it's not. You've got to look at the big picture because changes you make in one part of your portfolio necessarily affect the whole. And to truly understand the effect of any transaction, you've got to consider what that move means for your investment holdings overall -- and how any move leaves your portfolio positioned for the future.

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If you sell stock and put the proceeds into bonds, you've tilted your portfolio more toward the conservative end of the risk spectrum. Plow the proceeds into cash, and you've moved even more in that direction. More importantly, though, you've changed the balance of risk and reward in your portfolio. Essentially, you're saying you're willing to give up more potential gain in return for less volatility.

That's fine, as long as your decision is consistent with your long-term goals and tolerance for risk. But from what I see, people who use the phrase "taking money off the table" aren't talking about a long-term strategy. They're reacting to something going on at the moment, such as a fear among investors that the economy will falter or the market will drop.

Combine that urge to react to short-term issues with the failure to appreciate how moves in one investment affect the portfolio in its entirety, and investors who think in terms of "taking money off the table" can very well end up undermining their long-term investing strategy.

To avoid that possibility, I recommend you simply settle on an overall mix of stocks and bonds that makes sense for your situation.

If you're saving for a goal that's decades away, you might keep 70% to 80% of your portfolio in stocks, even more if you're okay with seeing the value of your holdings bounce around a lot in the short-term.

If you're planning to tap your investments sooner, you'll want to hold less in stocks.

Once you've chosen the right blend for you, stick with it except to rebalance periodically -- say, once a year -- to restore your portfolio to its target allocation. If stocks outperform bonds one year, you would sell some stocks and put the proceeds into bonds to get back to the right mix. This way, you're not letting emotional reactions to market ups and downs dictate your investment strategy.

I can imagine that some readers are now saying, "Wait a minute. Isn't rebalancing just another way of 'taking money off the table?'" The answer is "no."

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For one thing, rebalancing is systematic, not based on subjective notions of investments being overpriced or poised for a setback. There's also no false sense that you're removing money from the investment equation when you rebalance. It's clear you're taking money from one investment and putting it into another with the goal of maintaining a trade-off between risk and return in your overall portfolio.

Finally, people generally talk about taking money off the table when they have a gain or when an investment has recently soared. With rebalancing, it's the relative proportions of the assets that dictate action. Thus, even if both stocks and bonds have a down year, you would still rebalance by selling some of the asset that performed better and plowing the proceeds into the one that did worse.

Bottom line: Forget about this notion of "taking money off the table." It's misleading and potentially harmful. Instead, focus on creating and maintaining the mix of stocks and bonds that's right for you.