Are You Over-Weight? Your Investment Portfolio that is…

How do you know if you are overweight?  You could step on a scale but I am not talking about that kind of overweight.  While I will admit I came up with this idea standing in the shower (yes, I come up with blog ideas at the oddest times), the “overweight” I am referring to is regarding your portfolio.  More specifically, I am asking you, the reader, how do you know if you have too much of one type of an investment in your 401k, IRA, or any other investment account.

There are many ways to determine the answer to this question.  In fact, this blog could turn into a book about asset allocation.  I am going to attempt to keep it simple by explaining how my firm determines if you are overweight.

After creating an asset allocation model that strategically apportions investments among asset classes based on your risk tolerance, time frame and goals, we measure the balance of each allocation relative to one another.  For example, let’s suppose you invest in just four different asset classes for simplicity (you would likely have more than four to be properly diversified).   Taking it one step further, again for simplicity, you have 25% of your investment in each of these four asset classes.  Now, let’s suppose you want to rebalance the portfolio one time per year (we typically rebalance twice a year) at the end of the year.  You notice that your portfolio now looks like this:

Investment A: 31.25%

Investment B: 25%

Investment C: 28.75%

Investment D: 15%

What would our team do in this situation?  Assuming the strategic asset allocation was not changing (e.g., we want to maintain 25% in each asset class), we would examine the variance from the target.  By examining the variance from the target, you take into account how the other investments in the portfolio performed relative to each individual investment.   For example, if you set up a 20% variance-from-target goal, any investments that are representing a change of more than 5% (25% target x 20% variance) should be rebalanced.  In this example, we would likely sell some of Investment A and use these proceeds to buy Investment D.  Of course, you would need to consider tax consequences and fees associated with these transactions prior to making any changes.

By periodically rebalancing your portfolio, you can avoid being overweight and eat all the cheesecake you want.  More importantly, you can, without emotion, sell high and buy low.

Click here for a free download of the Foreword (written by NFL Legend Ronnie Lott) and Chapter 1 of The Art of Retirement written by Gary Williams, CFP®.

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