Determining Your Appropriate Asset Allocation
Ascertaining your individual financial situation and goals is the first task in constructing a portfolio. Important items to consider are age and how much time you must grow your investments, as well as the amount of capital to invest and future income needs. An unmarried, 22-year-old college graduate just beginning his or her career needs a different investment strategy than a 55-year-old married person expecting to help pay for a child’s college education and retire in the next decade.
Achieving the Portfolio
Once you have determined the right asset allocation, you need to divide your capital between the appropriate asset classes. On a basic level, this is not difficult: equities are equities and bonds are bonds.
But you can further break down the different asset classes into subclasses, which also have different risks and potential returns. For example, an investor might divide the portfolio’s equity portion between different industrial sectors and companies of different market capitalizations, and between domestic and foreign stocks. The bond portion might be allocated between those that are short-term and long-term, government debt versus corporate debt and so forth.
Reassessing Portfolio Weightings
Once you have an established portfolio, you need to analyse and rebalance it periodically, because changes in price movements may cause your initial weightings to change. To assess your portfolio’s actual asset allocation, quantitatively categorize the investments and determine their values’ proportion to the whole.
Rebalancing Strategically
Once you have determined which securities you need to reduce and by how much, decide which underweighted securities you will buy with the proceeds from selling the overweighted securities.