Despite what investing might look like in movies and TV, the purpose of investing your money isn’t to get huge overnight returns. While it’s great if it happens, the majority of investors need to work at gradually building their wealth over a long period of time – often at least a couple of decades. The reason for this is because investing can be risky and building your wealth slowly can help to mitigate some of that risk.
The risk of investing and the potential returns are correlated, with high risk leading to higher potential returns. An investor who has a very high risk tolerance and is OK with potentially losing everything might actively play the stock market to invest in the most cutting-edge companies and read the trends to spot and invest in the next best thing. On the other hand, investors with low risk tolerance might take a very different approach, putting everything that they own in bonds. Most people will fall somewhere in the middle between these two. While most of us don’t want to risk everything, we do want to see some healthy investment growth. One of the best ways to minimise risk while improving your returns is to build a balanced and diverse portfolio.
What Can You Invest In?
Investment types are known as asset classes. Similar to any kind of classification system, certain investment types tend to be grouped together due to having similar characteristics and regulations. The core investment asset classes are:
Equities such as mutual funds and stocks. These involve investing in a portion of something, such as a company. This asset class also includes index funds and exchange traded funds (ETFs). Visit WealthSimple to find out more about Canadian ETFs and how they work. WealthSimple offers a lot of advice on ETFs, how to get started with investing in them, and how to choose the right ETF for you.
Fixed income, such as bonds. This involves joining together with others to lend money to a corporation or the government and earn returns on the interest that is generated.
Cash equivalents such as money market funds and cash on hand. These are highly accessible sources of cash that allow you to earn money quickly.
How Your Age Impacts Your Portfolio:
A diverse and balanced investment portfolio will look different depending on several factors including your goals for investment and your age. If you are currently investing as a way to build your wealth for retirement, your risk level will be based on your plans to retire and how far off retirement is likely to be for you. Younger investors tend to be in a position where they can make bigger risks, as they have more time to recover from their losses compared to older investors who are closer to retirement, as they will want the guarantee of their money being accessible to them when they need it.
A common guideline that investors use when determining their level of risk is to subtract their age from one hundred to find your best combination of investments. For example, if you are thirty years old, you would get seventy, meaning that you should go for 30% safer investments and 70% riskier ones. However, with that being said, since we are all living for longer these days, experts suggest that you subtract your age from 110 instead.
What Is Asset Allocation?
A balanced portfolio typically refers to a combination of both bonds and stocks in your investment portfolio. It uses a strategy to use growth in the stock market to improve wealth while protecting your portfolio with less risky investments such as bonds to mitigate any market downturns. Stocks are typically behind the growth of the portfolio and subsequent wealth, while bonds provide additional stability and balance the investments.
Typically speaking, a balanced portfolio will have a 50/50 or 60/40 combination of both stocks and bonds. Since you have a combination of both, it allows you to balance your risk level and improve your possible return on investment.
How Will a Balanced Portfolio Look?
A balanced portfolio is one that strives for an even split between stocks and bonds on an ongoing basis. In addition, it will also generally include a balanced geographical investment range. For example, there might be a combination of Canadian, US, and international holdings.
Why is a Balanced Portfolio Important?
When it comes to using investments to grow your wealth, slow and steady will usually win the race. Because of this, a balanced portfolio is something that all investors should consider in order to achieve financial success.
When Should You Be in a Balanced Portfolio?
While there are no hard and fast rules when it comes to the type of investments that each individual investor should choose, there are some typical situations where a balanced portfolio will be a good option. Consider that you might not always achieve the highest returns as the markets tick upward, however, balancing your portfolio will help you to avoid losses during a market downturn due to the stability provided by the bonds. Consider being in a balanced portfolio during the following situations:
- When your investment runway is over ten years, but you do not want to weather large fluctuations in your account over time.
- If you are retired and feel more comfortable with accepting variances in your account based on market performance.
- If you are not very experienced with investing and want to achieve a good compromise between achieving your financial goals over the long term while mitigating risk.
- If you’re in a younger age category and are investing to meet future financial goals such as buying a home in a few years.
Does Your Risk Tolerance Change?
New investors at any point in their lives might feel worried about losing equity, which can lead to selling driven by panic at low points, instead of staying the course and holding onto investments. On the other hand, investors with a higher tolerance to risk might end up trying to make a quick profit by surfing the investment waves.
For investors with a longer investment horizon, it might be possible to cope with the market retractions compared to those who are closer to retirement or already retired. Younger investors who are earning income and have a longer investment timeline might often have a higher risk tolerance due to the fact that they have more leeway for making these risks and more time to correct them before reaching their financial goals. Tolerance for risk will often drop accordingly as people move into different stages of life with more consideration for accumulating wealth and approaching retirement.
What You Need to Build a Balanced Portfolio:
Today, it’s easier than ever to invest with options to self-manage your funds, work with a bank or other financial institution, or work with a financial advisor who can manage the investment strategy day-to-day. There are several factors to consider when it comes to building a balanced portfolio including your current level of experience and comfort when it comes to investing and your knowledge of fund management fees, including what’s best for your budget.
Because of this, it’s important to choose the right management solution for your portfolio. If you expect appreciable short-term growth, you are likely to be disappointed if using an investment strategy that is solely focused on protecting your current level of wealth since your funds will be staying the same despite market growth. On the other hand, if you are a cautious investor who is more concerned with protecting your current funds, a high-risk solution could cause you high levels of stress. To build a balanced portfolio, you will need:
- Think carefully about how much risk you can tolerate and communicate this to your advisor or management company
- To consider your current investment situation and the stage of life that you are currently in
- To spend time researching to choose the right investment option based on whether you would prefer self-managed funds or working directly with an advisor or a financial institution
- To compared management fees, which could ultimately have an impact on your profits when paid overtime
- To stay apprised of your investment outcomes over time and rebalance your portfolio when needed
Why is Rebalancing your Portfolio Important?
Even if you start out with a 50/50 split of stocks and bonds, your portfolio may become more in favor of one or the other over time, for example, if there is a large uptick in stock performance. As a result, your risk level will change and need attention. Reallocating your gains is an important strategy for rebalancing your portfolio, including taking the proceeds from selling successful stocks to purchase more bonds and create more balance. Since your investments can change over time, it’s important to ensure that it is tracked and rebalanced on an ongoing basis.
A balanced portfolio is important to mitigate your level of risk while ensuring that your wealth grows. How to balance your portfolio will depend on a number of factors including your investment goals and risk tolerance.
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