The Essentials Of A Well Balanced Portfolio

When it comes to investing, personal discipline and portfolio balance are key. For investors who strayed from such principles, Covid-19’s impact – which sent the Sensex tumbling over 35%, causing it to be one of the worst-performing global markets – has been an unpleasant reminder. Balancing (and diversifying) a portfolio is critical in reducing market risk and lowering volatility. It is important to understand the essentials of a well-balanced portfolio before you dive deeper into the world of macro-economic events.

A balanced portfolio with careful asset allocation helps reduce market risks. Ideally, it should feature stocks, mutual funds, commodities, and perhaps even long-term bonds. To better understand and apply the concept of a well-balanced portfolio, here are essentials that you should take note of.

Prioritize Managing Risks

The principle idea behind a well-balanced portfolio is risk management. Many financial advisors would recommend you to periodically rebalance your portfolio to protect against volatility and optimize returns. Remember to keep the following in mind:

• Assess your risk tolerance before you allocate funds. If you are not a risk averse investor, include some mid-caps with blue chips or ETFs. If you are considerably conservative, stick to blue chips almost exclusively, or perhaps invest less in stocks and more in long-term securities such as bonds.
• Spread your investments across different geographies. Now that investing in US markets has been made easy with Vested Finance, shielding yourself from local risks by investing in US stocks could be a way to manage risk.
• Consider investing in assets that have been pre-screened by professionals. For example, consider Vests – which are curated portfolios made for varying risk profiles. They’re dynamically balanced and can save you considerable effort.

Strategic Asset Allocation and Diversification

One way to diversify is to adopt asset allocation. When engaging in strategic asset allocation, we assign a target allocation for each asset within the portfolio. For example, a 70:30 mix of Indian to US stocks may be appropriate and can give investors additional sector and geographic diversification.

Nevertheless, equity markets as a whole are subject to both business and market risks, and more so for individual stocks. Thus, a savvy investor can look to ETFs to enjoy the additional diversification they provide. In addition to market-based risk, an investor is also exposed to time horizon-based risk. Typically, the longer the investment horizon, the higher the risk an investor can take. This is because a longer investment horizon gives you more time to recover from the negative impacts of economic cycles and the inevitable ups and downs of the markets.

Tactical Asset Reallocation

The tactical asset allocation strategy traditionally involves splitting capital between 4 asset classes – stocks, bonds, commodities and cash. But if your preference is the equity market, an equivalent strategy could also be deployed within stocks . Within stocks, you can diversify across companies of different sizes or between domestic and foreign stocks.

Here, your first aim should be asset allocation, followed by securities selection. As multiple studies (some dating back to 1991) have shown, 90% of a portfolio’s return can be attributed to asset allocation. As per the efficient market hypothesis, the market is able to price in most publicly-available information almost immediately. Thus, it is challenging to predict price movement in the short-term. Therefore, predicting performance at the asset-class level might be more prudent.

As an investor, you should:

– Monitor global markets, and

– Change your asset allocation per macro trends

Tax Efficiency

You can also minimize your tax burden with a well-balanced portfolio. It’s possible to improve gross and post-tax returns without compromising safety and liquidity. For example:

• There are mutual funds and exchange-traded funds that can be tax-efficient
• You can improve the tax efficiency of your portfolio by making investments in stocks you plan to hold for one year or more
• For investors holding shares in foreign companies, such as those investing in US stocks, a holding period of 2 years or more would have their returns qualify as long-term capital gains. The going rate for this is 20% (plus surcharges and fees), but with the benefit of indexation. Read about how taxation works when investing in the US here

Conclusion

As an investor, you should select a mix that aligns with your personal and financial goals. A well-balanced portfolio does not have to excessively-diversify away from the “growth” part of the portfolio (by cutting down its notional allocation). Instead, a well-balanced portfolio leverages less-volatile stocks (such as blue chips stocks) or bonds, which traditionally have negative correlation vs. stocks, to complement growth-based selections. There is no cookie-cutter approach in building a well-balanced portfolio, so it’s important to regularly observe the performance of our investments and adopt appropriate strategies accordingly.

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