I have always maintained you should never go wrong with a good balanced portfolio.
The problem most investors' experience with a balanced portfolio is that once they put it in place, over time their portfolio tends to shift from something that is well diversified and distributed proportionately between different asset classes (such as stocks, bonds and cash) to a completely different mix from where they began. This type of shift can have a significant effect on investment risks.
When you first build your investment portfolio, it should be reflective of you as an investor. It should take into consideration your investment objectives, time requirements, appetite for risk and your general investment knowledge.
If you put in the effort to set this in motion and don't adjust it for five years, will it still look the same? Will your investment objectives, time horizon and appetite for risk have changed?
Most likely your original asset allocation or portfolio will not line up with where you are in life five years after you started the process — or if it does, the original proportions of stocks, bonds and cash have changed due to market fluctuations, reinvested dividends, interest and capital gains.
Becoming overweighted in any one asset class can become a threat to your savings because most investments in our portfolios behave differently. Some are used for safety and some are used for growth and each type of asset in our savings should react to changes in the world independently from the others.
For example, you may have wanted only 40% of your investments attributed to the stock market. If the broader index that you have bought into goes up by 10%, that component of your portfolio would go up by 4%. If the index went down 5%, that component of your portfolio would only go down 2%. What if, over time, your portfolio became overweighted in that area and it went from 40% to 60% and the corresponding index went down 20% or more? Now, instead of seeing a drop of 8% in that portion of your savings, you would see a surprising 12% drop.
This is how rebalancing back to your original position based on your investment objectives and risk tolerance can reduce the associated risks of investing in any particular asset class. Taking those profits out before the correction can actually turn a potentially negative situation into a positive one.
You may decide to rebalance just because it feels right or because you believe there are dark days on the horizon. Whatever your method or rationale, don't wait too long to sell out of that growing investment and remember what a wise man once told me: "You will never go broke taking a profit."
— Doug is a senior associate with Investment Planning Counsel. www.ridingteam.ca