When people talk about "balance" in a portfolio, they're talking about mixture. As in baking, you need certain proportions of different ingredients to get the desired result. Depending on how you put them together, flour, salt, sugar and water might get you bread or they might get you cake, and investments are much the same. While the exact mix of investment types will be unique for each person, there is a recipe you can follow to acquire and maintain a balanced portfolio.
Review your goals. Just as it makes no sense to use a recipe for muffins when you want to make pancakes, your portfolio isn't balanced unless it addresses your purpose for the money, your timeline and your risk tolerance. Even if you've been investing for decades, it makes sense to pause and check in on what you really need.
Determine an investment mix. Work from the big picture to the details, starting with your ideal mix of stocks, bonds and cash before moving to specific sectors or investments. For now, just stick to percentages. If you need a place to start, the Iowa Public Employees Retirement System has a free asset allocation tool (http://www.ipers.org/calcs/AssetAllocator.html), and many online brokerage firms offer tools that integrate with your account.
Translate your percentages into dollars. If you don't yet have a portfolio, begin with the amount of money you have to invest. If you do have a portfolio, use your current account balance plus any additions you plan to make in the next year. Multiply your percentages as decimals -- 30 percent becomes 0.30, for example -- times your total portfolio to determine what dollar value belongs in each section of your portfolio.
Compare your ideal portfolio dollars with your current portfolio dollars. Determine how much you need to increase or decrease each sector to align with your ideal, balanced portfolio. If you're starting from zero, you can skip this step.
Plan sales and purchases. If you need to decrease a sector, you can choose to sell assets that are performing well and realize a gain, or skim off some less-than stellar options. Use that money to purchase assets in sectors that need a boost.
- Remember, you don't have to rebalance all at once. You can keep an eye out for good buy and sell opportunities and make your trades over a period of several days or weeks. If you don't want to lose any assets, focus your new investments on the sectors that need a boost to help balance the whole portfolio.
- Beware of overzealous rebalancing. Constant adjustments can add up big bills in the form of commissions and fees, not to mention the risk of a loss in a down market. Don't worry about a few percentage points here and there -- reviewing the big picture once or twice a year is enough for most investors.
- CNN Money; Get Your Portfolio in Balance; George Mannes; February 2007
- Prudential: Investment Basics: Balancing Your Portfolio;
- Charles Schwab; The Portfolio Pyramid: How to Diversify Your Investments; Bryan Olson; October 2007
- U.S. Securities and Exchange Commission: Beginners' Guide to Asset Allocation, Diversification and Rebalancing
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