Simply Investing: Portfolio balancing.
What is a balanced portfolio?
A balanced portfolio is whatever you want it to be. It could be 100% stock funds (risky). It could be 100% bond funds (low return and low risk). As advisors, we tended to lean more toward 60% stocks and 40% bonds. But it is up to you.
As you move from a single fund (I recommend a balanced fund to start)into multiple funds, portfolio balancing becomes an issue. In a single balanced fund, the fund manager will decide how many stocks versus bonds are appropriate at a given time in the market. You can stay in a single balanced fund for as long as you want.
However, as your portfolio grows, you should diversify into other mutual funds. You must decide your target balance between stocks and bonds as you add additional mutual funds to your portfolio.
Review of building a portfolio.
Insert Morningstar matrix here
To build a safe enduring portfolio that will help you sleep at night, you must diversify. Diversification is shown in the matrix above by having a mutual fund that covers each company size (small, medium, and large) for each investing type (growth, balance, and value). So, as the value of your investments grows, you should periodically add one mutual fund from each of these categories. So each time the value of my total portfolio grows (for me by $1,000), I will add another mutual fund from the same family to my portfolio.
Now, nothing is magical about adding a new mutual fund each time you grow by $1,000; you can easily choose any number. And also remember that you can say that I will sleep better at night with only one balanced fund. Once you have multiple funds, you must consider rebalancing your overall portfolio each year.
Why do I have to rebalance my portfolio?
We think of the stock market as one whole, with everything going up and down simultaneously. But this isn’t the reality of the complex world in which we live. Each segment of the market has its cycle. That is why it is beneficial to diversify into various size companies and various investment types. For example, bonds rise and decline differently from stocks. Company size also moves stock values differently. Large companies are like a pachyderm, giant and slow-moving. Midsize companies are more like a zebra, more petite, and quicker to change direction. Small companies are more like gazelles, rapid to change direction.
My apologies, but we have to do some simple arithmetic for the next step. Let’s assume you have six funds, as shown below.
- Fund A, a large growth fund, started at 500 and ended at six hundred.
Then we would calculate how much the fund has grown or lost by end value — beg value and divide by the beg value; then multiply this by 100 to get the percent change. For Fund A, this is [600–500] divided by 500 times 100, or a growth of 20%. We repeat this step for each fund in your portfolio.
- FUND B, a midsize company stock, starts at 350 and ends at 400, giving a percentage of 14.2.
- Fund C, a small-size company, stocks start at 500 and end at 400 for a percentage of — 20%.
- Fund D starts at 400 and ends at 420 for a percentage of 5%
Now how do you choose what to do?
My guidelines have been that I don’t have to do anything for any fund that changed by less than 10%. So for Fund D, we don’t need to make a change.
Fund C is at a bargain price, and if there are no other extenuating circumstances, it will make sense to sell some of Fund A and possibly Fund B and buy more of Fund C.
This rebalancing discussion is a very simplified version of rebalancing, and you should get advice from your financial professional unless you do it yourself. If you are doing it yourself, you need to consider all the information you can get about each fund before changing.
