A solid foundation for investing begins with an understanding of the individual investor’s goals, time horizon to meet those goals and risk tolerance. And while no one can disagree with the proposition that there is no sure thing as a guaranteed return on an investment, there is a great deal of disparity as to what is acceptable risk in attempting to achieve the desired rate of return. Additionally, each investor will likely experience varying levels of risk tolerance during their investing life. It’s important to recognize this reality and work to rebalance your portfolio accordingly.
The primary way risk tolerance is managed is through spreading your investments across various asset classes. A typical mix includes some combination of stocks, bonds and cash or money market securities. What percentage each category of asset will comprise determines if the portfolio is deemed conservative, moderate or aggressive.
How the balance in a portfolio can change
Assuming the proper balance is achieved at the onset, over time, market conditions can change the asset allocation. One asset class can show considerable growth and another may experience unexpected setbacks. If no external changes are made to the portfolio, the balance of assets may grow to be significantly different than when began and out of sync with the investor’s goals.
Rebalancing the portfolio
If it is determined the original balance was optimal, there are two ways to again reach this level. You can infuse new money into the portfolio, and buy the amount of the under-performing asset necessary to achieve the desired balance. Or, you can sell sufficient quantities of the asset performing well and buy a corresponding amount of the down asset. By opting for the second method, you are employing a sell high, buy low plan.
Of course, any number of circumstances may arise in your life that alters your investment goals and consequently your risk tolerance. Major life changes should always trigger at least a review of your portfolio and, perhaps, an adjustment as needed.
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