Financial planning experts agree that maintaining an adequately diversified and balanced portfolio is key to meeting your investment goals. The appropriate asset mix will vary for each individual depending on a host of factors including: age, income, net worth, financial goals, and risk tolerance. A well-constructed portfolio should also be tailored to meet long- and near-term financial needs. Investors, regardless of lifestyle, should strive to maintain a diversified portfolio made up of different asset classes.
How do I feel about risk?
Given the variability experienced in financial markets, it is important to distinguish between volatility, which tells how much prices are changing, and risk, which helps to gauge the probability of permanent loss of capital. When investors have a well-reasoned idea of what an investment is worth and buy at a low-enough valuation, they mitigate downside risk and are well positioned for upside volatility. When investing, the real risk to focus on is that which may lead to a permanent erosion of capital. Nonetheless, it is understandable that some investors simply sleep better at night when their investments don’t fluctuate dramatically. It all depends on the individual’s comfort level in dealing with variability in the market, which is an important factor to consider before investing.
What is my life stage and financial situation?
An individual investor’s tolerance for risk is typically influenced by the amount of disposable funds available for investing. A retired individual with a modest income and savings may have less tolerance for significant declines in the value of his or her portfolio – even if temporary – since the return generated on the investments is likely earmarked for living expenses. A high net-worth investor or younger individual in his/her prime earning years might have a higher tolerance for volatility because he/she has time to wait out a poor or sluggish business cycle that negatively impacts stock prices.
What should my portfolio mix look like?
Equities, most commonly stocks, represent shares of ownership in a company. A simple way to invest in equities is through the purchase of shares in a public company that is listed on a stock exchange such as the TSX or NYSE. Although the market price of equities might fluctuate greatly – up or down – in a short period of time, a well-researched basket of quality stocks can yield higher returns over the long term than other asset classes. Additionally, equities are a great way to fight inflation. Investors with a low tolerance for risk might consider a smaller weighting to stocks in their portfolio whereas more aggressive investors may have a portfolio that is heavily weighted to stocks.
Fixed-income investments – bonds issued by corporations or governments – pay investors a fixed rate of interest over a given period of time, after which the principal investment is returned. Although bonds have historically been considered a safer asset class, their value can fluctuate based on interest rates and inflation. For conservative investors, such as those who require a fairly steady stream of cash flows, bonds might make up a greater proportion of their portfolio.
Money market instruments – treasury bills, commercial paper, and other short-term securities – are traditionally considered to be the safest assets. Relative to other types of assets, these tend to be shorter term, highly liquid and low yielding. Their advantage is safety.
How should I monitor and rebalance my portfolio?
Over time, some of your assets will perform better than others. Wise investors optimize the long-term performance of their portfolios by monitoring the performance individual holdings and periodically readjusting their investments so that the intended asset allocation remains suitable. On the surface, this can look like you are selling your best-performing assets and purchasing more of your worst-performing ones. Remember that the market is volatile and the performance of each asset will change over time. By “selling high” and “buying low” you are following a basic rule of investing, which helps to build wealth over time.
How often should you rebalance your portfolio?
Most people rebalance their portfolios one to four times per year. While it is important to keep an eye on the weightings of particular investments and asset classes in your portfolio, an investor should be aware of the transaction costs associated with buying and selling securities. Frequent trading can eat away at the value of your portfolio. For most investors, rebalancing twice per year is sufficient.
Getting the best results from your investment portfolio requires time and discipline. Working with a financial professional to address the above questions can greatly help in setting clear priorities for the construction of a customized investment portfolio to help you reach your financial goals.