Updated on 09.15.14

Balancing An Investment Portfolio For The First Time

Trent Hamm

As the year ends, I’m thinking about one of the most common suggestions that people offer as an annual financial task: rebalancing my investment portfolio. For me, this is a relatively new concept, as I previously just selected something at random for my retirement money to go into and assumed it would do “well” without thinking too much about it.

Here’s my plan for rebalancing my portfolio each year.

Total your investment assets. For me, this includes the amounts I have in my retirement funds plus the amount I have in an external mutual fund. I try to identify everything either as a “safe” investment (bonds and treasury notes) or a “stock” investment, and I subdivide the stocks into safer and more risky investments.

Figure out your percentages. Many people encourage a heavy reliance on stocks if you’re young (they return well, but there is significant risk, especially in the short term) and a gradual shift to bonds and securities as you age (they’re much more stable and earn a better rate). I agree with this philosophy for the most part. I calculate the proportion that should be in stocks using a rewritten Money rule: to figure out what percentage of your money should not be in stocks, subtract 30 from your age and then double that number. For me, this means all of my investment portfolio should be in stocks right now.

Diversify within that area. As a beginning investor, my diversification is a split between more conservative index funds and more risky speculative funds. I tend to have money that I might liquidate soon in index funds, whereas money that’s headed for retirement is in more speculative funds for the time being. So, I have 50% of my investment in an index fund (including all of my mutual fund) and 50% of my investment in a speculative growth fund.

In the near future (two to five years), I am planning on starting a sliver of investments in individual companies, which I want to grow to about 20% of my overall portfolio, leaving me with a 40-40-20 split overall. I want to have some solid capital before I do this, though.

Rebalance annually. At the end of each calendar year, I look at the growth in each area and rebalance accordingly. Let’s say that my index funds actually did better than my growth funds this year, so at the end of the year, 52% of my money is in my index funds and 48% of it is in growth funds. I then transfer enough from the index funds to the growth funds so that their amounts are equal and move on with life.

When I reach the age of 31 (or so), I’ll start to slowly creep into more stable investments. I’ll still maintain the stock split, but before I figure up my split between those two, I’ll figure that a small percentage of my overall portfolio is in bonds and treasury notes. This slow “safety creep” is a hedge against a massive market downturn before I retire; even at my young age, it’s a bet against another 1929 or even another 2000.

Following this procedure each year will help me to keep my portfolio in shape and help me plan for a fairly early retirement. I must admit: that is a statement I wouldn’t believe I would make even as little as a year ago.

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  1. Ralph Morgan says:

    A couple of things
    1. I’d watch the cost of switching funds around – between fees and “buy-sell” spreads on unit prices, it can cost a bit to rebalance this way. I usually just work out which area has become under-weight, and target my savings for the coming year into this area.
    2. I don’t agree with a simplistic rule for working out how much to invest in growth assets (eg. stocks) vs. bonds and fixed interest investments. You’re much better off basing your asset allocation on your risk tolerance.

  2. Trent Hamm Trent says:

    I agree with Ralph’s points. Simple rules like the one above are useful for getting your feet wet and helping you decide what risk feels appropriate for you, not as a hard and fast rule.

  3. Tony Mahoon says:

    What about capital gains tax that you pay when you rebalance as well? I agree with Ralph, you should target your savings at the areas that are underfunded, rather than selling areas you have made gains in.

  4. rodgerlvu says:

    um i think we share the same idea..thanks to you, trent, for telling me all what you think

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