- Common mistakes made by many investors include a portfolio without enough diversification.
- When positions become oversized, it is in the best interests of investors to manage any risks.
- Robert Cannon of Cannon Wealth Solution discusses the rebalancing of portfolio positions to reduce risks for investors.
A good balance of asset allocation in an investment portfolio is 50% stocks and 50% bonds. Of course, the target allocation of each investor is different.
Diversification is all about ensuring that all stocks and bonds in a portfolio don’t go up or down simultaneously. Additionally, rebalancing is used to ensure one position does not become too large. When this happens, then a portfolio may become more weighted with one stock or bond.
In a recent report and newsletter to investors, Robert Cannon, owner of Cannon Wealth Solutions, discussed the techniques used for rebalancing. His report took into consideration that each investor has different goals and risk tolerance levels. Some key takeaways that transpired from the insights shared by Cannon were the following:
Exchange-Traded Funds (ETFs) often sell off their over-located positions at pre-determined times. They do this to buy more under-allocated positions. Every investor can learn a lot from this viable management technique.
There are, of course, some pros and cons to doing this. The pros of rebalancing are that severe over-allocations are prevented, keeping volatility to a minimum. Over-allocated positions are sold at a higher price and under-allocated positions are bought at a low price because they have underperformed.
Rebalancing may have some cons, especially for investors who have more confidence in some sectors. Also, some winning stocks may continue rising, therefore limiting the investor’s upside potential. Capital gains tax can also result from rebalancing for investors with taxable accounts.
At Cannon Wealth Solutions, we recommend an examination of allocations at least once a year, but preferably twice. There are ample benefits to fine-tuning a position, especially for reducing what is known as performance drag in the industry. It also allows our investors to maintain their original asset allocation while decreasing any risks within their portfolio.
Oversized allocations can be reduced by reinvesting or redirecting dividends into under-allocated positions. Additionally, some investors like doing this to add new money to their portfolios. They keep their over-allocated positions and buy into under-allocated ones to balance their investments.
At Cannon Wealth Solutions we warn clients of the pros and cons of redirecting. The pros of this are that winning performers are left to run, while the investor proactively manages taxable transactions. This action has moderate volatility and is a good technique for investors who want to keep adding money to their portfolio.
This is a slow process that won’t work for investors who withdraw their dividends or those who don’t want to add new money. With redirecting, investors also risk losing money if their substantial allocations in one sector start dropping.
Watch for opportunities
Not everyone has cash lying around for buying opportunities. That’s why every portfolio owner should have a list of stocks they are willing to sell if a buying opportunity presents itself. Stocks that should ideally be at the top of the list are those that are over-allocated.
The pros of this tactic are portfolio owners have a plan in place to immediately replace overweight investments with new opportunities. The cons are this has higher volatility, and time is needed to find investment opportunities.
Actively managing a position
Some people watch the markets daily, and this offers them the opportunity to trade around their positions. This does pose a high volatility risk but creates the potential for profits over and above the underlying 2% position with active buying and selling.
This can be exciting for some investors, but lots of experience in these types of trades is required because short-term trades need to constantly be watched. Investors should also be prepared for some losses.
Balanced allocations require an honest appraisal of a portfolio and an assessment of the risk tolerance of the investor. As wealth advisors, Cannon Wealth Solutions understands clients want financial stability for the future.
Portfolio rebalancing does not necessarily mean more profits but reduces the risk of holding onto high-performing positions that may lose steam going ahead. Of course, not re-balancing can also sometimes have an upside if some positions appreciate greatly, but some investors want to adhere to their tolerance risk-return level.
The more conservative the investor, the more often they should consider rebalancing. Investors who don’t mind adding more money to their investment portfolio are usually more tolerant of some risk, and redirecting can be a wise move for them. More active investors willing to have a high level of volatility can play a more active role in their rebalancing strategies.
Investment planning without proper rebalancing implementation cannot guarantee each client’s investment portfolio performs ultimately according to their investment plan.