Developing and managing your financial portfolio involves a series of steps to plan and reach your financial objectives, while gaining an understanding of the important factors under consideration when one begins to invest. From start to finish, they include:
1) Determine your goals: This is the “what” and “why” behind your investments. What are you working towards? Why is this important?
2) Determining your risk and expertise level: One’s risk level captures what you are willing to lose and how much you hope to gain.
3) Create a plan: How do you want to invest your earnings? What investment vehicles and products do you want in your portfolio? Mutual funds, ETFs, high-interest or tax-free savings accounts?
4) Choose a portfolio: 1) How do you want to allocate your assets; 2) What range of investment styles do you want to adopt; 3) How much are you investing and what type of fees are you willing to incur.
5) Stick to your plan and rebalance…
In reality, this isn’t a “last-step,” but rather, the jumping off point to managing your financial portfolio. In an ideal scenario we would do all our investment research early on and let our decisions play-out until retirement. Unfortunately, there are too many changing factors that allow this to be a sustainable approach: Markets and interest rates change, fund managers leave, companies face competition and decreasing market share. Even personal reasons will dramatically change what you are saving for.
The difficulty with this seemingly contradictory process—sticking and adjusting to a plan—varies with our risk tolerance. If we are conservative investors, bonds aren’t going to perform in a surprising fashion. The allocation of our assets in our portfolio will remain somewhat intact. If we take on moderate risk and have a balanced portfolio, however, we will need to rebalance more often. For example, during one year, bonds might become a larger percentage of our portfolio, and this will lead us to redistribute earnings to our equity portion, to keep the allocation of assets at pre-determined levels.
In general, we should be looking at our portfolio every quarter or more frequent if markets dictate or as we see fit. But the degree to which we make these changes, also reflects our ability to handle and comprehend risk and market behavior. Thus, a general rule of thumb is that your asset allocation should not deviate from its target by more than 5%. Too large of a change and too often can snowball and create added stress and discomfort, and lead to emotionally charged, rather than rationally thought out decision-making. Depending on your risk style, rebalancing will have the added benefit of allowing you to sell well-performing stocks to make room for under-valued new stocks. Rebalancing can also allow you to infuse new capital in your portfolio.