How do I Select Stocks for a Balanced Portfolio?
"Buy low, sell high" is the best advice ever given to investors. Implementing that advice is the challenge, since no one can predict when the high or low of any stock is reached. The U.S. Securities and Exchange Commission advocates a more balanced, long-term approach to investing through diversification and rebalancing. Creating and maintaining a balanced portfolio can help you weather the inevitable fluctuations in the financial marketplace.
Before you can select appropriate stocks to create a balanced portfolio, you must first define what a balanced stock portfolio is and what it should contain. The composition of your balanced portfolio could be completely different than your parents' balanced portfolio or your children's portfolio. You might have a moderate investment objective, while your parents might be conservative and your children aggressive. Regardless of your objective, your portfolio can still be balanced. According to CNN Money, a good target is between 15 to 20 stocks spread over at least seven industries.
Creating a balanced stock portfolio requires you to leave your emotions at the door and look at stocks objectively. You're not looking at individual companies as much as you're looking at the performance of individual stocks. The CNN Money website advocates selecting stocks that have a historical total return of more than 10 percent, as determined by combining the earnings growth rate with the dividend yield. Limiting your stock selections to those with a price/earnings ration of less than twice projected total return can help cull out high-risk companies. A conservative portfolio will be more heavily weighted with large- to medium-cap stocks, while an aggressive portfolio will have a larger percentage of small-cap, international stocks and emerging market companies.
Selecting stocks for your balanced portfolio is only half the battle. Keeping your portfolio balanced is the other half. Over time, some of your stocks will perform better than others. During times of high growth, your small-cap and emerging market stocks might skyrocket, while your large cap stocks might lag. The increased value of your small-cap stocks can throw your portfolio's balance off. You'll need to sell some of your small-cap stocks and use the proceeds to buy more large-cap stocks to restore balance to your portfolio. The SEC refers to this process as rebalancing, and recommends you review your holdings every six to 12 months to see if it needs rebalancing.
Invest Long Term
The market fluctuates, sometimes at a dizzying pace. Although the overall direction of the stock market has been upward for more than a century, that trend has seen plenty of downturns. If you dump your stocks when the market is down, you risk taking significant losses, but the SEC notes that investors who buy and hold stocks for long periods of time,15 years or more, are typically rewarded with strong, positive returns.
- CNN Money: Picking the Best Stocks For Your Portfolio
- American Association of Individual Investors: AAII Asset Allocation Models
- Investor: Stocks
- Securities and Exchange Commission: Beginners' Guide to Asset Allocation, Diversification, and Rebalancing
- Forbes: A Balanced Portfolio for a Balanced Life
Mike Parker is a full-time writer, publisher and independent businessman. His background includes a career as an investments broker with such NYSE member firms as Edward Jones & Company, AG Edwards & Sons and Dean Witter. He helped launch DiscoverCard as one of the company's first merchant sales reps.