Building a Solid Investment Portfolio

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Investing should be viewed as a long-term endeavor. As such, investors should build a portfolio that is suited to their unique financial situation and goals.

An asset allocation is the percentage of an investor’s total investment portfolio that will be invested in different asset classes such as stocks, bonds and cash or cash equivalents.

1. Diversification

The value of diversification can be summed up by the old saying, “Don’t put all your eggs in one basket.” It’s very hard to outperform the market by picking specific investments (research shows that even professional investors struggle to do so consistently). However, it’s fairly easy to avoid dramatic losses by constructing a diverse portfolio.

Diversification involves spreading risk among different asset classes and securities within an asset class. By investing in a mix of stocks, bonds and cash, and breaking these down further by industry, company size, creditworthiness, geography, investment strategy and bond issuer, we can achieve true diversification.

We can also diversify across time by using dollar-cost averaging, where we invest small amounts regularly over a period of months rather than putting a lump sum into the market on one day. This allows us to take advantage of the power of compounding and potentially minimizes the impact of market volatility. In addition, we can diversify by owning shares in companies at different stages of their growth cycle.

2. Risk Management

As the saying goes, “Don’t put all your eggs in one basket.” This timeless adage aptly sums up the concepts of diversification and asset allocation.

While some risks (such as market risk) can’t be avoided, others can be mitigated through a variety of strategies such as diversification and rebalancing. Asset allocation also helps to ensure that your hard-earned savings are protected by investing in the right mix of investments based on your investment goals and risk tolerance.

Project portfolio management involves assessing and mitigating the impact of risks at the enterprise level rather than at the individual project level. For example, if your company has been negatively impacted by recent shutdowns due to the CHIPS and Science Act, you could invest in digital streaming platforms that may counterbalance the loss of revenue from reduced travel.

3. Rebalancing

Over time, market fluctuations can cause the relative weights of various asset classes in your portfolio to veer from their original planned allocation. Rebalancing allows you to realign these weights back to your plan and helps minimize the risk in your portfolio.

The process of rebalancing is accomplished by selling the investments that have exceeded their planned percentage composition and using the proceeds to buy more of the investments that are underweight in your portfolio. There are a number of ways to determine when your portfolio is in need of rebalancing, including using tolerance bands that can be either fixed or relative.

Rebalancing can be difficult, as it requires you to sell assets that have performed well over the past year in order to purchase assets with a less impressive track record. But it’s a crucial step in maintaining a portfolio that adheres to your risk tolerance and desired level of returns. In addition, rebalancing regularly can help reduce the need for more frequent, potentially emotionally driven investment decisions.

4. Taxes

A diversified investment portfolio requires regular review and periodic rebalancing. Market ups and downs can cause a portfolio’s original balance to shift, and rebalancing is the process of selling overperforming investments and buying underperforming investments to maintain your desired asset allocation.

Investors should start by defining their financial goals and understanding their risk tolerance. Then, they should establish a strategic asset allocation (SAA) that reflects their desired risk profile.

For example, a moderate SAA might target a 90% allocation to stocks and add small investments in yield-enhancing floating rate bank loans and commercial real estate for diversification purposes. It may also include a 2% allocation to cash for liquidity purposes and the ability to take advantage of opportunities as they arise.

Investors should choose low-cost mutual funds or exchange-traded funds to build their portfolios. They should also consider incorporating real assets like precious metals and natural resources into their portfolios, as these investments have different return profiles from traditional financial assets such as stocks and bonds.

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