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What Does It Mean If an Investment Portfolio Is Balanced?
By SmartAsset Team,
2024-07-26
Creating a balanced portfolio is a key investment strategy that aims to manage risk and optimize returns. By incorporating a diverse mix of assets such as stocks, bonds and sometimes alternative investments, a balanced portfolio helps spread risk across multiple asset classes. This approach not only minimizes the impact of market volatility but can help you reach your financial goals in a way that aligns with your with your risk tolerance.
Balanced portfolios may not look the same for every investor, but they do have a few key elements that help you minimize risk while seeking growth. These elements include diversification and stability, adjusting for risk tolerance, and regular rebalancing.
Diversification helps investors both manage risk and add stability to their portfolios. Investing in a variety of asset classes, such as stocks, bonds, cash, real estate and other investments can help investors mitigate the impacts of market volatility . Each asset class responds differently to economic conditions, so when one performs poorly, another may perform well, balancing out potential losses.
Investors typically include stocks in a balanced portfolio for their growth potential. Stocks offer higher returns over the long term but come with increased risk. On the other hand, bonds provide more stability and predictable income but offer lower returns. By combining stocks and bonds, a balanced portfolio can help you capitalize on both growth and security. This blend also helps cushion your portfolio against sharp fluctuations that might affect individual investments.
Investors can further stabilize their portfolios by diversifying investments within each asset class . For example, within the stock portion of a portfolio, you could invest in a mix of sectors, such as technology, healthcare and consumer goods. This internal diversification reduces the risk associated with a downturn in any single sector. Similarly, the bond portion might include a mix of government, corporate and municipal bonds to further minimize risk.
In addition to managing risk, diversification within a balanced portfolio can also improve returns. By investing in a broad range of assets , investors can benefit from the growth of multiple sectors and markets, rather than relying on the success of a single investment.
Adjusting for Risk Tolerance
Risk tolerance refers to an investor’s ability and willingness to endure market volatility and potential losses. Each investor has a unique risk tolerance , influenced by factors such as financial goals, investment horizon and personal comfort with uncertainty.
A balanced portfolio isn't static. Instead, it should evolve with your risk tolerance. For example, younger investors with longer time horizons might have a higher risk tolerance, allowing for a higher percentage of stocks in their portfolio. In contrast, investors nearing retirement may have a lower risk tolerance and prefer a higher allocation to bonds, which provide more stability and lower returns.
Adjusting to risk tolerance also involves regular assessment and rebalancing of your portfolio. As market conditions change and personal circumstances evolve, your risk tolerance changes and your initial asset allocation may no longer be appropriate. Periodic reviews and adjustments are necessary to keep your portfolio's balance in line with your risk level.
Ultimately, aligning a balanced portfolio with your risk tolerance helps to manage anxiety during market fluctuations. By carefully considering your risk tolerance and adjusting your portfolio accordingly, you can create a more resilient investment strategy that stands the test of time.
The Importance of Regular Rebalancing
Regular rebalancing helps investors maintain a balanced and effective portfolio. Over time, the values of different assets in a portfolio change due to market fluctuations. Without rebalancing, the portfolio can drift away from its intended allocation. The following are some of the reasons it's important to regularly rebalance your portfolio:
Maintaining desired risk levels: One of the primary benefits of rebalancing is maintaining the right level of risk for your circumstances and goals. As certain assets appreciate or depreciate, the risk profile of the portfolio changes. Rebalancing involves selling overperforming assets and buying underperforming ones to return the portfolio to its intended allocation. This keeps your portfolio aligned with your risk tolerance and financial goals.
Enhancing long-term returns: Rebalancing can also enhance long-term returns by encouraging a long-term approach to investing. Rebalancing helps investors follow the “buy low, sell high” principle, which can be difficult during periods of market volatility. By regularly readjusting your portfolio, you can capitalize on market inefficiencies and avoid the emotional pitfalls of investing.
Staying aligned with financial goals: As life circumstances and financial goals change, regular rebalancing ensures your portfolio continues to meet your needs. For instance, as you approach retirement, you might want to shift toward more conservative investments. Regular rebalancing ensures your portfolio evolves in line with your changing objectives and circumstances.
Working with a financial advisor can help you understand how to best balance your portfolio and the frequency with which your investments need to be rebalanced.
Bottom Line
A balanced portfolio is a powerful tool for managing risk and optimizing returns through diversification across various asset classes. Regular rebalancing maintains your portfolio’s intended allocation, ensuring that it aligns with your risk tolerance and financial goals. By regularly adjusting the proportions of your different assets to maintain a balanced portfolio, you can mitigate the impact of market fluctuations, improve long-term returns and stay on track to achieve your financial goals.
Tips for Building a Balanced Portfolio
Though creating and maintaining a balanced portfolio doesn't have to be complicated, it does require regular assessment of your goals, risk tolerance and portfolio performance. If you don't want to do this all alone, you can consult a financial advisor. Finding a financial advisor doesn't have to be hard. SmartAsset's free tool matches you with up to three vetted financial advisors who serve your area, and you can have a free introductory call with your advisor matches to decide which one you feel is right for you. If you're ready to find an advisor who can help you achieve your financial goals, get started now.
Part of building a balanced investment portfolio means creating an asset allocation that aligns with your personal circumstances and financial goals. If you're unsure where to start, use an asset allocation calculator to help outline your portfolio.
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