Many investors build their portfolios to offset risk with return. An investment approach that balances risky assets with stable ones is known as a balanced portfolio — for example, a portfolio in which high-risk securities are paired with low-risk Treasury notes.
Why is a balanced portfolio important?
A balanced portfolio often has equal portions of stocks and bonds. According to Investopedia, it is a strategy favored by investors with moderate risk tolerance.
Some investors are susceptible to panic at sudden swings in market conditions. A balanced portfolio works well for them because it keeps its value relatively steady.
What kind of strategies do investors take to build a balanced portfolio?
More conservative investors who want to keep the money they have rather than expand their income will pursue a defensive investment strategy. Such investors tend to focus on capital preservation, targeting only assets that have safe but low returns, like high-grade bonds, certificates of deposit, money-market funds, and blue-chip stocks.
Aggressive investors want to emphasize higher returns. They will pursue growth investment strategies, targeting stocks and financial instruments with lower credit ratings but higher yields. Such investors typically have a greater appetite for short-term losses in the interests of long-term growth.
In deciding which investment strategy to pursue, investors will want to consider their net worth and income, which affects their ability to sustain risk, but also their tolerance for market volatility.
A balanced portfolio should allow investors to capitalize on the market when it is doing well. At the same time, it should provide protection from a downturn.
Why should I build a balanced portfolio?
During the financial crisis, a balanced portfolio of stocks and bonds proved useful, as Forbes has detailed. Investors who took a buy, hold, and rebalance approach suffered fewer losses than those who invested in risky assets.
When deciding which assets to include in their portfolios, investors may want to consider assets beyond stocks and bonds — for instance, real estate, mutual funds, cash equivalents, or private equity. Diversification of assets tends to reduce overall investment risk.
But whatever the assets, a balanced portfolio will divide them evenly or nearly evenly. The overarching goal of a balanced portfolio is to combine assets that produce some yield and appreciate over time with less volatility than an aggressive investment strategy.
One way to assemble a balanced portfolio is to open a Questrade account, as per the instructions at Canadian Couch Potato. It will allow you to set up a target portfolio on your own and will give you hints to help you maintain a balanced portfolio.
What is rebalancing?
The rebalancing technique is important in maintaining a balanced portfolio. For example, if a portfolio is composed of 50% stocks and 50% bonds, it will occasionally be necessary to cut back some assets and boost others. When stocks gain, the investor would sell some shares and buy bonds to keep the portfolio at 50% each.
Morningstar has compared rebalancing to flossing one’s teeth or dusting under the refrigerator. In other words, investors often forget to do it. But without it, an investor’s exposure can creep up, making them more vulnerable to market downturns. Analysts disagree over how often investors should rebalance. An investor’s rebalancing method will depend on how much their assets fluctuate and how different their returns are.
The Securities and Exchange Commission (SEC) suggests that investors check their portfolios every six to 12 months to see if they need to rebalance. But the frequency and degree of rebalancing don’t matter so much as that investors have a rebalancing procedure in place and stick to it. Investors should set a target range and then, at any point when the market nudges an asset at least 5% beyond the target range, rebalance their portfolio, according to the Wall Street Journal.
Another factor to consider when rebalancing is the tax implications of previous investing choices. If an asset being sold is subject to capital gains tax, an investor may prefer to drop it entirely and move their capital into a different asset class.