FINANCIAL FOCUS

Are you overweight?

   In this installation of Financial Focus, we will discuss the topic of an unbalanced, potentially “overweight” portfolio… 

     Fund managers and financial advisors often provide parameters to their clients regarding the “weight” of their stock/bond/asset holdings. Based on one’s age, retirement plan, and/or the current “risk” level of the markets, the percentages of each holding can vary, or be adjusted. 

     A popular long-term approach has included the well-known 60-40 split between Stocks (60%), and Bonds (40%) in an investment portfolio. For several decades this formula was the most common distribution, and considered perfectly “balanced.” Stocks have typically returned about 10% annually, while bonds have averaged about 5%. Over the past few years, however, many individuals have implemented a 60 (stocks) – 30 (bonds) – 10 (cash) approach, as rising interest rates have increased the risk factor. Cash generally returns less than stocks/bonds, but is considered safer for those who feel more comfortable with a little less risk, and are willing to trade off some of their potential ROI (return on investment). Having some available cash has its positives as well, as there is liquidity available for another investment opportunity, and/or emergency funds at hand. Also, the difference between returns in the two formulas is very insignificant over the past decade. Studies over the last 40 years indicates that the 60/40 approach has beat the 60/30/10 approach by only a small margin, while decreasing each decade. The margin of outperformance is as follows: 

40 years = .3%     30 years = .21%     20 years = .17%     10 years = .02% 

     One important overlooked factor within the stock weighting of a portfolio, for those who self-manage, is the constantly changing percentages of your holdings. For example: If you currently hold 10 stocks, worth $10,000, with each individual security valued at exactly $1,000, your portfolio would be perfectly balance at 10% for each holding. Should stock #1 increase to $1,200 in value, and stock #2 decrease to $800 in value, while stocks #3-10 remain the same, you would still have 10 stocks equaling $10,000. However, the balance, or weight, has changed for stocks #1 and 2, as stock #1 now represents 12% of the portfolio, and stock #2 is now only 8%. In this example, the figures are very small, but large increases, or decreases, in certain stocks can throw the portfolio off-balance.

      If one is not diversified equally from the beginning (all holdings with same percentage), the numbers can be more skewed, putting portions of the account at more risk. For instance, if a portfolio consists of 10 stocks, but 3 are all in the same industry, say technology (which is very volatile), a jump in share prices in that industry could unbalance the holdings to a large degree. You could easily have 30% of your portfolio (3 stocks out of 10) accounting for 50% of the value. It may not seem like a big deal when stocks are advancing, but it becomes much more troublesome when markets are declining. It may not always be possible to perfectly diversify to exact equal percentages, however, there are different strategies to combat the “overexposure” to one stock or sector.

     One obvious way to manage these percentages is by actively tracking the figures, and reducing, or adding to, holdings when they become unbalanced. This does require quite a bit of attention, though a monthly “re-balance” may work out just fine on most occasions. When self-directing your own portfolio, consider taking profits periodically from the heavier weighted equities, to bring them back in balance with the others (remember that “no one ever went broke taking a profit”). Some ideas for distributing these profits include purchasing additional shares of your “underweight” stocks, purchasing steady dividend stocks to hold longer-term, and/or holding in cash for the next opportunity. Remember that you will owe taxes on sold positions at the end of the year, although not if the portfolio is placed in an IRA.

     As always, one’s risk tolerance, age, and retirement plan need to be considered when deciding which approach to choose. Stay disciplined, have a plan, and follow it. Review your options and consider consulting with a financial literacy expert by connecting with a professional on the website www.Becauseyourmoneymatters.com. 

     For additional discussions and education, please continue to visit our BLOG section here on ASTRO-FIN, where we provide periodic updates on a variety of topics.