If you’re an investor who wants to focus on long-term results rather than short-term wins, you need to know how to apply asset allocation and rebalancing to your portfolio. These two investment concepts are essential to building a foundation for your financial success.
1. Asset Allocation
Asset allocation refers to investing in many types of assets, including stocks, bonds, real estate, minerals, precious metals and more to balance your investment risk and reward. But educated investors know that asset allocation is far more important than security selection. After all, even if you buy the right investment at the right time, watching it double in value won’t do you much good if you had invested only 1 percent of your money into it.
This is why you need to focus on percentages, not dollars. The amount of money you have fluctuates daily, but the percentage never changes: You always have 100 percent of your money — never more, never less. So instead of trying to decide how much money to place into a given investment, decide the percentage you’ll invest there. For example, if you put 20 percent of your money in a given asset class, you’ll know to buy or sell if the allocation drifts far beyond your chosen level (say, if the asset rises to 25 percent or falls to 15 percent).
How you allocate your money among the 20 major asset classes and market sectors depends on your goals and how much time you have to achieve them. For example, two people might own identical investments, but the person saving for a retirement 30 years away will allocate money among investments very differently from the person who’s planning to pay for college in two years. That’s why professional financial planners create asset allocation models for clients only after developing a thorough understanding of the client’s goals.
Whenever there’s a dramatic drop in prices of some given asset class, investors — and the media — often overlook the fact that other asset classes are rising. Rebalancing takes advantage of situations like these. When one asset class is up, you sell some and buy more of the asset class that’s down. Thus, you can sell overperforming assets and buy underperforming assets.
Rebalancing is important. If you don’t do it, your portfolio could eventually comprise too much of one asset class and too little of another. That could be devastating to you if the over-weighted asset class suddenly falls in value — as those who had all their money in tech stocks discovered in 2000, or real estate in 2007. You can reduce this risk by maintaining a diversified portfolio. But, of course, no investment strategy can guarantee you’ll never lose money.
If you’re unsure how to apply these concepts to your investments, talk with an objective, fee-based financial planner.
Investing strategies, such as asset allocation, diversification or rebalancing, do not assure or guarantee better performance and cannot eliminate the risk of investment losses. There are no guarantees that a portfolio employing these or any other strategy will outperform a portfolio that does not engage in such strategies.
Ric Edelman, Chairman and CEO of Edelman Financial Services LLC, a Registered Investment Advisor, is an Investment Advisor Representative who offers advisory services through EFS and is a Registered Principal of and offers securities through Sanders Morris Harris LLC., an affiliated broker/dealer, member FINRA/SIPC. You can connect with Ric on LinkedIn at linkedin.com/in/RicEdelman or on Facebook at facebook.com/RicEdelman. Or follow him on Twitter at @RicEdelman.