Two free lunches: diversify and re-balance

Tuesday, July 4, 2017|Managing Investment Risk|
  • Diversify and Re-Balance

Situation

Ramifications of diversification and re-balancing affect everyone.

Symptom

Too little diversification and re-balancing increase your portfolio risks.

Solution

Apply the techniques of two free lunches of investing to your nest egg.

“Excellence is not a skill. It is an attitude.”
—Ralph Marston

Diversification and re-balancing strategies are two essential, time-tested portfolio tools. They improve your chances of achieving better consistency of long-term returns. Tasty free lunches are still being served in your investing patch.

Diversification spreads your risks among a variety of investments. Re-balancing makes periodic adjustments to bring allocations back in line with targets set within your road map. I assume that your road map is in place.

Experience shows that asset mix decisions have the greatest impact on your portfolio returns than any other factor. The foundation of investing your nest egg requires patience, discipline and clear investment policies.

Diversification is one necessary safeguard. You don’t want problems arising in any asset class to ruin your well designed portfolio. Diversification increases the odds of you being right more often. If some selections are suffering, others can help cushion the rest.

Initial allocations and weights of your portfolio selections will drift over time as markets rise and retreat. When drift becomes significant, it affects your investment profile and typically requires some re-balancing.

Periodic re-balancing strategies sell some assets and buy others within your asset mix. My preferred time to re-balance is when you inject new money into the portfolio or withdraw some. Use re-balancing techniques as portfolio tweaks, not for wholesale changes.

Possible ways

I highlight 10 ways to achieve portfolio changes:

  • Different Asset Classes: Choosing different asset classes is the first step of diversification. The most common are stocks, bonds, cash and real estate.
  • Economic Regions: Portfolios may include selections from Canada, USA, Europe, Far East and emerging markets.
  • Foreign Currencies: Investment selections can be purchased in Canadian funds, US dollars and the Euro. Some can also be hedged.
  • Time to Maturity: A portion of the portfolio could have a range of investment maturities. From as short as 30 days to as long as 30 plus years.
  • Level of Liquidity: Cash components, such as term deposits, could be easily cashable. Real estate typically requires a longer investment horizon.
  • Type of Investments: Portfolios may contain investments such as individual stocks, mutual funds, exchange traded funds, index funds, private equity and hedge funds.
  • Management Style: Portfolios may be constructed with active or passive management styles. Perhaps, choosing one style as the core with a sprinkling of the other.
  • Tactical Allocation: Rebalances portfolios into selections with the highest potential for gains.
  • Sector Emphasis: Some portfolios emphasize specific sectors of the economy, sometimes to the exclusion of others.
  • Investment Quality: Some investors trade quality for higher yields and the potential for bigger losses. Hopefully, because they have the added risk tolerance.

Portfolios ought to contain a variety of investments that don’t all move in the same direction. Although, that is not always possible. Always keep in mind what is in your best interests.

Diversification and re-balancing tools should be front and centre in managing your portfolio. A sensible approach is to invest your nest egg to reduce portfolio risks and aim for more consistent results.

That makes for happier investing outcomes. Moreover, those who diversify and re-balance worry less. Two free lunches not to pass up. Just spread some excellence on your nest egg.

About Adrian Mastracci, Discretionary Portfolio Manager, B.E.E., MBA  My expertise in the investment and financial advisory profession began in 1972. I graduated with the Bachelor of Electrical Engineering from General Motors Institute in 1971. I then attended the University of British Columbia, graduating with the MBA in 1972. I have attained the “Discretionary Portfolio Manager” professional designation. I am committed to offering clients the highest standard of personal service by providing prompt, courteous and professional attention. My advice is objective, unbiased and without conflicts of interest. I’m part of a team that delivers comprehensive services and best value in managing client wealth.

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