The golden rule of investment is to diversify your portfolio. That’s a concept most investors understand, however they are not always sure how to achieve it. Diversification is simply spreading your money across several different investment types (such as cash, bonds, property and shares) and then within each investment type choosing a range of individual securities or funds.
Within a portfolio there are assets which can change significantly in value. These are growth assets such as property and shares. On the other hand, income assets such as cash and bonds are quite stable in value. This means that over time, if left untouched, the growth assets will be an increasing percentage of the total amount invested in the portfolio.
Growth assets are more volatile than income assets and so as the percentage weighting towards growth assets increases, so does the risk. Investors who do not keep a regular eye on their portfolio values can find themselves over time with a portfolio that is much riskier than the one they started out with.
To get around this problem it is necessary to rebalance a portfolio – that is, to keep each investment type at the desired percentage of the total portfolio. This is done by buying and selling assets to keep the percentage in line. Of course, growth assets, being volatile, can also fall in value. The art of rebalancing is to buy more growth assets when they have fallen in value and to sell some off when they rise in value. If this is done so as to maintain the desired percentage of growth assets, the result should be an improved return. Assets will be bought when they are cheap and sold when they are at a peak. Rebalancing is a key aspect of managing a portfolio over the long term.