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Are You Overweight? Your Investment Portfolio, That Is …

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How do you know if you’re overweight? You could step on a scale, but this is not that kind of overweight. This kind of “overweight” regards your portfolio.

More specifically, how do you know if you have too much of one type of an investment in your 401k, IRA or any other investment account?

There are many ways to determine the answer, but here’s a simple explanation of how to make this determination.

After creating an asset allocation model that strategically apportions investments among asset classes based on your risk tolerance, timeframe and goals, measure the balance of each allocation relative to one another. For simplicity, suppose you invest in just four different asset classes (you likely would have more than four to be properly diversified).

Taking it one step further, again for simplicity, say you have 25% of your investment in each of these four asset classes. Now, suppose you want to rebalance the portfolio one time per year (which typically should be done twice a year), at the end of the year. You notice that your portfolio now looks like this.

  • Investment A: 31.25%
  • Investment B: 25%
  • Investment C: 28.75%
  • Investment D: 15%

What would you want to do in this situation? Assuming the strategic asset allocation was not changing (e.g., you want to maintain 25% in each asset class), you would examine the variance from the target. By examining the variance from the target, you take into account how the other investments in the portfolio performed relative to each individual investment.

For example, if you set up a 20% variance-from-target goal, any investments that represent a change of more than 5% (25% target x 20% variance) should be rebalanced. In this example, you likely would sell some of Investment A and use these proceeds to buy Investment D (of course, you would need to consider tax consequences and fees associated with these transactions prior to making any changes).

By periodically rebalancing your portfolio, you can avoid being overweight and eat all the cheesecake you want. More importantly, you can, without emotion, sell high and buy low.

Gary S. Williams, CFP, CRPC, AIF, is president and founder of Williams Asset Management, in Columbia. He can be contacted at 410-740-0220, Gary@WilliamsAsset.com and www.WilliamsAssetManagement.com. For information about his book, The Art of Retirement (with the foreword by NFL Legend Ronnie Lott), visit www.theartofretirement.org.