Introduction
“Too much of anything is bad” is quite a cliche, but it is largely true. As it applies to normal everyday life, it also applies to investing. When building up a portfolio of investments, it is important that you do not concentrate your funds in one asset or security class over and above others. Why this? Any investment involves two angles: one is return, that is, the profits or rewards generated from investing. The other is risk which entails the amount of capital that may be lost to the investment. Thus, while seeking the returns, you must also be aware of the risks involved.
Having a balanced portfolio helps you to manage the relationship between the risk and the reward. You mainly do this by diversifying across many assets. We know that some investments or assets typically carry more risks and therefore, greater returns, than others. On the other hand, some assets exist to preserve and “save” your cash, rather than “grow” it. These ones are usually risk-free. A proportional portfolio usually involves these varying classes of assets.
Rebalancing your Portfolio: A Guide
It does happen that your portfolio might become thrown off balance; that is, you may find your portfolio tilting to one asset type rather than others. When this happens, you must rebalance. Here, we lay out the steps to do so.
- Determine Your Investing Targets & Risks
Whether a portfolio is balanced is mostly a question of personal choice, and based on the preferences of the investor. An investor who pursues an aggressive policy will mostly be comfortable with having say 30% of the portfolio in high-growth but mid-market cap stocks. Thus, first determine which type of investor you are. You can easily answer that by considering your investment goals, but more importantly, the risks attached, alongside an array of other interests.
- Carry Out Checks on Your Portfolio
Upon determining your style of investing, you can then take a look at the contents of the portfolio to know if they fit properly according to plan. With the checks, you will discover areas in which you may be lacking or over- concentrating your capital.
- Purchase More of a Lacking Asset Class
To get more practical, you can get your portfolio rebalanced in many ways. For instance, if you discover that you are not committing enough capital to one asset class as you should according to plan, then you may decide to dedicate fresh capital to it.
For instance, upon carrying out checks, if you discover that your portfolio is overwhelmingly tilted towards high-risk growth stocks, you may want to buy more investment-grade corporate bonds or even treasuries to balance out the risks.
- Sell More of a Concentrated Investment
Another way to rebalance your portfolio to achieve a decent risk-reward proportion is to sell some of your positions in a concentrated investment, especially one that can be deemed as carrying some high degree of risk.
For instance, if you see that your portfolio is disproportionately concentrated on junk bonds, you might want to liquidate some of them to attain the desired symmetry. Getting a balanced portfolio is ultimately desirable.
However, confusing circumstances do arise. The key to this is to constantly review your positions to ensure that they are in line with your investing plans.