Investment Planning for a Balanced Portfolio

Since the words “sub-prime mortgage crisis” were first uttered more than two years ago, investment markets have been in constant state of flux. 2010 has been just as much of a roller coaster ride, though it’s rarely been mentioned by the media. From February until May investment markets advanced by approximately 10 percent (as evidenced by the performance of the NYSE composite index), but those gains were all but lost between May and July.  

How can you use these turbulent times to your advantage? The following theories are simple but they take guts to implement.

Rebalancing 

Experts agree that diversification is the only investment strategy that works in the long run. Diversification requires that you invest in different products such as cash, fixed-income investments (bonds), and equities (stocks) because these investments appreciate and depreciate at different times. Some or all of these investments can be held in mutual funds (baskets of investments that are sold as a single product), which will achieve further diversification. Diversification will essentially protect your portfolio from a complete freefall.

The next step is to determine a mix of investments (i.e. an asset allocation), based on your individual needs, that is appropriate for your risk tolerance and the amount of time you wish to have your money invested. Once this mix is established, stick to it! Designing your asset allocation takes introspection and the advice of a financial planner or investment advisor and will ensure that your investments are correctly chosen to achieve your short, medium and long-term goals.  

It is inevitable that your recommended asset allocation will change during your lifetime due to ever-changing circumstances – including your age, your marital status and the stage of your career. Each of these factors impact how your money should be balanced, in order to reap the most from your investments.

Let’s assume, for example, that you have a moderate risk tolerance and have determined that your recommended asset allocation is 50 percent cash and fixed-income investments, and 50 percent equities.   

During a Market Downturn

If equity markets tumble by 30 percent, your asset allocation might suddenly look something like this:

In order to rebalance your portfolio back to your recommended allocation you will need to invest in equities.  You will notice that investing in equities during a market downturn will essentially achieve half of the renowned “buy low – sell high” strategy because you will have purchased equities while their prices were low.

During a Market Rebound

As equity markets rebound, which they inevitably do, you might find that your asset allocation suddenly looks like this:

To rebalance your portfolio back to a 50 percent equity position, you will have to sell some of your equities or add fixed-income investments to your portfolio. If you choose to sell some equities during a market boom, you will have achieved the second part of the “buy low – sell high” strategy since you will have sold your equities during a strong equity market.

Other Considerations

The rebalancing strategy outlined above will keep your investment portfolio on an even keel for the long-term. Although I’ve focused mainly on asset allocation above, there are other facets of diversification, such as diversifying investments by geographic location (domestic vs. international) and by the mutual fund’s management style (growth vs. value investing), that can also enhance a portfolio’s performance. If your portfolio is of a significant size ($100,000 or more), then you should probably be working with an investment advisor to optimize your investment return with the lowest level of risk possible. Smaller portfolios will also benefit from diversification but the costs of actively managing a smaller portfolio will essentially erode any investment income produced in the account.

It is also important that you consider the costs of such an active portfolio management style. Costs may come in the form of investment commissions for individual stocks and bonds and management expense ratios and deferred sales charges for mutual funds. In general, fees erode the performance of a portfolio and should be considered carefully when implementing any strategy. To mitigate these fees, rebalance your portfolio only periodically, such as once or twice a year.

Another cost worth considering is the tax consequences of investment sales. Taxes pose another threat to the long-term success of any investment strategy and should be considered in advance of any sale. While taxes should not drive investment decisions, they can be mitigated with the help of your investment advisor.

In summary, rebalancing involves deciding on the optimal mix of investments in your portfolio and adding investments or selling investments in order to maintain it. Although it sounds simple, it is deceptively difficult to implement. Few people have the courage to pour money into equity markets during market downfalls. Similarly, people loathe selling equity investments during times of market strength. Yet this simplistic and “contrarian” strategy is the key to using market turbulence to your advantage.

Disclaimer:

The information contained in this article is for general information purposes only. The information is provided by Monique Madan, and while we endeavor to keep the information up to date and correct, we make no representations or warranties of any kind, express or implied, about the completeness, accuracy, reliability, suitability or availability with respect to the information, products, services, or related graphics contained on the website for any purpose. Any reliance you place on such information is therefore strictly at your own risk.