With rapidly changing financial markets comes the need to balance your portfolio to ensure you are on track to achieve your investment goals and maintain the desired asset allocation.
This idea might sound straightforward enough. But, in fact, balancing risk and rewards can be deceptively challenging in many cases. The process entirely depends on a host of factors, including your assets of interest and individual risk tolerance, which are likely to differ from someone else’s.
Simply put, balancing your portfolio means building the proper investment structure that fits your own risk profile and financial goals. However, the matter isn’t limited to just “do it and forget it,” as you need to commit to regular ‘rebalancing’ to make sure your portfolio stays ‘balanced.’
Rebalancing here is an essential step to bringing a portfolio back to the planned asset allocation that guides your purchases. It involves buying and selling different investments to restore the balance between the potential returns against the amount of risk you’re comfortable with.
In a nutshell, balanced portfolios protect your investment and keep it relatively safe from market downturns and unexpected events.
How to Rebalance Your Portfolio?
Let’s assume that your portfolio has an asset allocation of 80% risky investments (for example, 55% for stocks, 15% for gold, 10% for cryptocurrencies) and 20% for fixed-income instruments, like bonds.
As the crypto market has been growing by leaps and bounds, the cryptocurrency component may become, percentage-wise, much higher than the gold side. Due to these changes, the allocation would make drift to 50% stocks, %7 gold, and 22% cryptocurrency, based on market valuation.
Since cryptocurrency is still an extremely risky investment, prone to big swings in short timeframes, you start to see that volatility affects the value of your portfolio. Continuing the example above, you might prefer to regain the original asset allocation by selling 12% of your portfolio’s crypto holdings and using the proceeds to purchase stocks or gold. This would maintain a margin of safety and bring the portfolio back in line with the planned diversification.
On the flip side, during a bear crypto market, you might see the value of your digital coins fall, lowering the percentage they make up into your overall portfolio. Still, assuming you are a crypto enthusiast and believe in the long-term potential of this nascent asset class, you don’t need to react to market volatility.
Staying the course in this case could be recommended and there would be no need to revisit your allocations at this point.
Future-value-oriented guidance here provides a dynamic strategy that adjusts to temporary valuations. This could be better than employing a strictly fixed concept as you, instead, will have greater flexibility to choose from a range based on asset categories.
Assessing the Types of Risk
The investment risks are inherent to any asset class, so the mitigating risk in a portfolio requires understanding the unique characteristics of each asset you invest in.
For example, the systematic risks related to cryptocurrencies tend to be relatively higher than other assets. Additionally, these risks involve regulatory crackdowns, tax implications, and corporate adoption, among other factors that could affect the gross value of your portfolio at once.
Meanwhile, stocks have a different risk profile as you may opt to invest in blue-chip companies, whose stocks tend to be relatively stable.
Mitigating Asset Risk
The best way to manage portfolio risks is through diversification. Cryptocurrency can provide great returns but can wipe out just as easily. Blue-chip stocks can guarantee regular dividends and capital gains, but if you are a risk-taker, they might not generate the return you need to meet your ambitious financial goals.
You can solve this dilemma by spreading your capital across a mix of assets. The core idea is that when one asset performs badly, the other many do not, and vice versa. For example, the gold market tends to do well when inflation is high, while a booming stock market and a stronger US dollar tend to drive down the bullion value. Investing this way can help you offset the weakness of one asset with the strengths of another.
Just as importantly, it’s highly recommended to take a long-term approach to your portfolio. It’s impossible to completely avoid market-wide volatility and cyclical downturns. But building your portfolio around long-term investments will give the pooled assets the time they need to recover their value once a specific crisis has passed.
Balancing is a crucial part of building your portfolio. Through the process, you can keep both the risk profile of your investments and the ROI rate consistent long-term.
If you are worried about risk, the golden advice is to invest cautiously. Look first to see if your portfolio is heavily concentrated in specific markets or assets. Then build a well-diversified portfolio with the balance of how much money you have tied up in conservative/low-yield products and risky/high-reward investments.
Managing risk and rebalancing are essential skills for any investor. Such an ability enables them to strike the right balance between putting their portfolio at risk and missing their targets for capital appreciation.