by Nick Ford

Created on: May 08, 2011

Investment advisors recommend that an investment portfolio is diversified across a range of investments. This is to ensure that the investor has a balance of short and long term investments, and has taken an appropriate balance of risk and reward to reflect their personal needs and risk appetite.

Investments are usually diversified across a range of bond, equity, property, commodities, cash and geographic region.  Good investors know their appetite to risk and establish target percentages of their wealth to be held in each class. Investors adverse to risk tend to have a higher holding in bonds. Investors who are less risk adverse are recommended to maintain a higher proportion of equities. Investors in their thirties are encouraged to have a higher holding in equities than an investor approaching retirement. The reasoning is that a younger investor can benefit from the long term appreciation of shares whereas an investor approaching retirement, and a need to draw down upon his/her investments is more likely to be exposed to adverse market fluctuations.

Good investors need to regularly value their investments to ensure that they remain within their target percentages of the overall portfolio. This is because, depending upon market conditions, some asset classes will outperform other classes in the portfolio.

Investors may also wish to rebalance their portfolio to reflect changing market conditions or to reflect changes in their personal circumstances. In volatile markets investors might wish to hold more cash than would be the case in calm markets. Investors might wish to adjust their proportions held in corporate bonds or equities to reflect economic conditions. As people approach retirement they should be re-weighting their portfolio towards bonds.

Apart from rebalancing the risk profile of the portfolio there are other sound reasons for periodically rebalancing a portfolio. It is a good discipline which focuses the investors mind. What does he expect from the process? The process supports a buy low, sell high policy. It avoids being caught in a speculative bubble. For example, over the past few years commodities have had a bull run meaning that diversified portfolios are likely to be overweight in commodities. A sell off to rebalance the portfolio might be desirable to lock in profits. Understandably investors are much more reluctant to rebalance a rising asset class than an underperforming one. If the portfolio is not rebalanced the portfolio will gradually

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