How to Determine Weights in an Investment Portfolio
Investments carry individual risk. Overall portfolios carry a total risk that derives from the risks of stocks, bonds, Treasury bills (T-bills), mutual funds, exchange-traded funds, real estate investment trusts, annuities and money-market accounts the portfolio contains. No exact formula exists to determine the mix of investments you should have. You can follow guidelines based on your tolerance of risk to determine what weight to give each type of investment. The higher the risk, the higher the potential returns.
When you near retirement, you may want to lower the risk in your portfolio. Since stocks tend to fluctuate in value more than bonds and Treasury bills, you may want to move the bulk of your investment money to bonds and T-bills to protect it. You will still receive interest, and your remaining stocks provide you with the opportunity to grow your investment value. Bonds and T-bills don’t grow in value, but they do offer steady returns. You could decide to keep some mutual funds that invest in diverse assets to provide further opportunity for growth while offering the risk protection of diversity.
If you want to make up for losses and build your portfolio value quickly, you can opt for higher-risk investments in your portfolio. Individual stocks can offer you the opportunity for profits, though they carry higher risk than bonds, T-bills and money-market funds that pay you interest. You could adopt the practice of maintaining a smaller percentage of your portfolio in interest-bearing investments and using your interest payments to purchase more shares of stock. You run the risk of losing money on your stocks, but you could maintain some protection with a small portion of your portfolio in safer investments.
A Balanced Approach
You may find yourself somewhere in the middle in terms of risk tolerance. You can create a portfolio with equal percentages in stocks and interest-bearing vehicles such as bonds, T-bills and money-market funds. You could decide to split your portfolio into thirds, with stocks, interest accounts and mutual funds. You could add a small portion of real estate exchange-traded funds or trusts to provide the opportunity for growth in an area outside of stocks.
Balance by Market
Instead of counting all stocks as having the same risk, you can divide your stock investments between small companies, large companies and international companies. Each of these market segments tends to outperform the others at various times, so by spreading your stock investments among them, you position yourself to profit from a surge in any one of them.
Kevin Johnston writes for Ameriprise Financial, the Rutgers University MBA Program and Evan Carmichael. He has written about business, marketing, finance, sales and investing for publications such as "The New York Daily News," "Business Age" and "Nation's Business." He is an instructional designer with credits for companies such as ADP, Standard and Poor's and Bank of America.