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Constructing a Balanced Portfolio

I’ve noticed that clients moving to my practice often tend to focus on specifics when choosing where to put their investment dollars rather than looking at the larger picture.  Some investors might look solely at the year-to-date return of a fund.  Others might look at the internal expenses, looking for the lowest cost.  The track record of a fund manager might be the most important factor, or the type of investments (such as long-term bonds or dividend-paying stocks). 

In reality, there is no single factor that should be considered above all others.  Constructing a portfolio requires balancing a number of variables at the same time, and often involves compromising in order to select investments that have the best chances for a positive outcome.  To help, I’ve outlined the process we use at The Krajniak Group below:

  • Understand your time horizon.  Before even starting, realize that the most appropriate investments can change dramatically depending on how long you have to invest or how willing you are to stomach volatility (the up and down movements of the market).  If you need to use your investment dollars to pay a tuition bill in 3 months, it may not be worth investing that money at all.  One calendar quarter is not a lot of time to generate a return, and a loss early on might not be recovered in time.  Surrender charges or front loads (fees charged) generally will have more of a negative impact on a shorter time horizon. 
  • Know your experience and tolerance for risk.  If you don’t have experience with the type of assets you are considering purchasing, you should also consult a professional to see what sort of risks you are up against.  For example, if you have only ever invested in CDs, you may not be prepared for the relatively higher risk of losing money associated with an equities-based portfolio.  A good financial planner will help you determine what amount of volatility you are comfortable with.  A better one will help you with understanding what amount of volatility you might need to achieve your goals.  Read on…
  • Get a plan.  While this can be as simple as understanding that you are young and should save as much as possible, a more comprehensive plan can provide more direction and structure to your decisions.  For example, if you’ve followed the above instructions you may find you are comfortable risking 8% of your portfolio for the chance to gain, say 15% over the next year.  That said, what if your financial plan shows that you only need 5% return to achieve all of your goals?  If that were the case, you could have the option to take less risk.  Having a higher probability of success and more predictable returns could be the result of a doing a little homework in advance.  Conversely, what if your investments are returning less on average than what your plan says you need?  Finding this out early may give you more time to make changes without the need to do something more drastic.  By the way, the above numbers are for illustrative purposes only and do not necessarily indicate a specific plan or investment allocation. 
  • Now that you have defined your investment time horizon, your tolerance for risk, and created some blueprints for what your needs are, you’re ready to start choosing investments.  Generally, more volatile investments such as equities tend to have a higher return, but also a higher risk of loss.  This makes them more appropriate for longer time frames where the potential for higher returns would have a larger benefit.  Less volatile investments such as US treasury securities or short-term bonds could be a good idea for shorter time horizons or a lower tolerance for risk.  The overall economic picture should be considered.  Increasing interest rates may have an impact on the price of some investments.  Global economic considerations could affect the value of certain currencies, which could have an impact as well.  You should of course consider the cost of a given investment, but weigh this against the expected return.  Sometimes an expensive investment might be worth the money.  Other times, it is not.  When constructing our portfolios, we also like to find investments with a low correlation to each other.  Getting this information involves some research.  It could also help you lower the impact of a bad market and make your returns more predictable.  You should have several types of investments to help diversify your accounts.  How much you invest into each type should depend on your goals. 

If this seems like a big job, that’s because it is.  None of it is rocket science, but there are dozens of variables (and not all of them are something it is possible to know).  I’ll leave you with this tip: Understand your limitations and your goals.  Do what you can to protect your potential for growth.  If you haven’t got the time or the knowledge to build and maintain a portfolio, consider speaking with The Krajniak Group (or if not with us than we recommend another Certified Financial Planner®) to help you manage things.  You should at least seek advice to see if what you have set up has weak points that you can address.  To quote Ben Franklin, you might find that “an ounce of prevention is worth a pound of cure.”

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