Walking The Tightrope: Balance Your Portfolio To Keep Your Future On Track
Personal finance is almost always a balancing act. You'll need to strike a balance between spending and saving. You'll want to balance your expenses against your income. You would be wise to make sure the risk and potential reward stay in balance. Most importantly, though, your portfolio will benefit if you keep your investments in balance.
There are many ways to think about balancing your portfolio. At the most basic level, you need to balance the possibility of earnings against the guarantee of security. Generally, riskier investments offer a greater possibility of high returns. However, you still must balance risk and reward. More specifically, that means creating an allocation of assets that provides an acceptable level of risk and reward.
When you set up your portfolio, you'll want to create an asset split between riskier growth investments and safer income investments. The level of risk you're willing to tolerate, based on your age, income and individual preferences, is called a "target allocation." You can use a number of online tools to figure out a target allocation that works best for you, or you can speak to a financial planner for assistance.
When you select your investments, you do so based on your target allocation. If you're targeting 40% growth stocks, 30% international stocks and 30% bonds, for example, you'll divide your money between those three categories in that proportion. That's balancing your portfolio.
However, balancing isn't just a one-time affair. Just like keeping your balance on a tightrope, balancing your assets requires careful attention. Natural movement will cause you to lean one way or another. You'll need to take action to bring yourself back to center. In the same way, the natural movement of economics will cause your portfolio to grow or shrink in certain areas. It takes careful action to maintain your target allocation.
Imagine, for example, that your growth stocks do really well. They double in value. Other parts of your portfolio don't change. You've now got 60% of your assets invested in growth stocks, leaving you more exposed to market contractions. If things suddenly go bad, you could lose a larger percentage of your money than your comfort level allows.
It's unlikely that swings in the market will be that drastic, but they do occur. That's why it's important to periodically review your portfolio and rebalance it. Sell assets that are performing well, and use the proceeds to buy assets that are less represented in your portfolio.
It can feel uncomfortable when you're selling assets that are doing well and buying those that are less exciting, but it's best for the growth of your portfolio. When a vibration comes on the tightrope, the gymnast who's well-centered will be able to stay on, while the gymnast leaning too far in one direction might fall off. When market corrections occur, prices head back toward their equilibrium ratio. Your strong performers may lose value and your weaker performers may gain. By maintaining a good balance in your portfolio, you'll be poised to minimize the impact of the former and take advantage of the latter.
How often should you rebalance your portfolio? The answer to that depends on the costs involved. Factors to consider include: taxes, transaction fees and how many different assets your portfolio holds. In general, the frequency of rebalancing should be somewhere between yearly and quarterly.
Just like learning to walk on a tightrope, investing looks like magic, but it really boils down to a lot of little actions done right. Learning to balance and rebalance your portfolio will take time, but the rewards can be considerable. If you're unsure about the balance of your portfolio, take the time to speak to a qualified financial planner.
Your Turn: How frequently do you check on your portfolio? Are you a constant monitor kind of investor, or do you prefer a set it and forget it type of style? How has that influenced your investment decisions?