Portfolio Balancing Part 3 – What Should Your Portfolio Look Like?

Over the course of the first and second articles we’ve investigated how the four main asset classes can be used in your personal investment portfolio to manage your monthly expenses, while maintaining the liquidity necessary to your lifestyle. To make for an exciting conclusion of this three part series, we’re now going to look at precisely how it is that you can balance the categories of assets in your portfolio to ensure the most effective outcomes.

While an individual portfolio’s structure will depend on the long-term goals of the investor them self, the general themes will usually be the same:

Cash Instruments are consistently the smallest portion of the portfolio, as it they represent stagnant money. While it is important to maintain at least 5% of your portfolio in this category to ensure that you can make payments and purchases during times of opportunity, this amount will generally be kept to a minimum.

Fixed Income positions will generally take up a majority position of a portfolio, because of their ability to manage an individual’s living expenses. By keeping at least 30% of a portfolio in fixed-income securities, an investor is able to apply the benefits of their portfolio towards their lifestyle today, as opposed to delaying gratification.

Equity Securities should ideally take up the remaining majority position of a portfolio that Fixed Income Securities do not already cover. Equity Securities represent your willingness to save for the long-term future. By holding them, you must be able to afford the long-term commitment required to hold these stocks until they reach their appropriate value.

While this category may take a second-priority to fixed-income (because you’re going concerns right now should always take priority), the greater returns generally seen by equity investments over the long-term will make up for this differential, and create the balance of returns that make them worth the purchase.

Physical Assets should be evaluated within your portfolio against their ability to facilitate your long-term financial goals. If you bought a house with the specific intentions of fixing it up to improve its value, you should look at it as an investment that incrementally increases in value based on the amount of time you spend improving it, and then maybe consider that to be a portion of your Equity Securities investments. If you bought a house based on your ability to get an affordable mortgage, you can consider it as a regular cost that requires additional supplementation from a strong fixed-income portfolio.

From a practical portfolio standpoint, the following examples all serve as a specific portfolio model that can be used to maximize the value you get from your personal investments:

  • Investing for Income

    This is the portfolio that is best tailored towards an individual entering their early-mid earning years. You have bills to pay, maybe a mortgage, and you need to make ends meet, while still making reasonable contributions towards the future. You’ll need less liquidity because you’ll have planned out your incomes well enough to handle them with your fixed income investments.

    Your equity securities will also be a bit smaller compared to other portfolios because you’re more concerned with reducing your living obligations. Your goal here is to strengthen your position today, so that you can build a greater future tomorrow.

    Money Instruments: 5-10%
    Fixed-Income: 70-80%
    Equity Securities: 10-25%

    Physical Assets

    You’re trying to pay off the balance on that home/car loan, so your physical assets should be looked at as holding back your fixed-income payments. Balance those payments out so that you can free yourself from that obligation.

  • Investing for Growth

    This portfolio is made for people in the mid-late earning years of their lives, looking to kick-start their retirement savings. Your bills and debts are under control, and you’re entering the peak of your salary years. Now is the time to start making the equity commitments, while holding a bit more liquidity so that you can be ready to pounce on the market whenever those big earnings opportunities arise.

    Money Instrument: 10-30%
    Fixed-Income: 10-50%
    Equity Securities: 40-60%

    Physical Assets

    In this portfolio, your assets empower you to generate returns. They provide you with equity for leverage, and act as an investment opportunity in themselves through improvements. Consider your physical assets as a supplement to your equity securities, and start thinking about how it is you can cash out on this value.

  • Investing Towards a Goal

    This portfolio is tailored for people with specific goals in mind. Buying a home, taking a vacation, or saving for a child’s education are all examples of concrete goals in the mid-term future, which can be saved for through a portfolio. Because we have a tangible goal on the line, we want to have certainty about the availability of funds by the time of the deadline. This means that risk, as well as stagnant cash, is generally unacceptable. We want predictability more than anything, which makes this strategy similar to the above income portfolio, except that it allows for a bit more flexibility in the use of equities.

    Money Instruments: 5-10%
    Fixed Income: 50-75%
    Equity Securities: 15-45% (focus on reliable dividends for this model)

    Physical Asset

    A discrete goal should generally be considered against its contribution towards your portfolio’s overall value. If you are making a purchase (such as a house), think of how it is that this goal contributes to your overall net-worth, as well as how it will serve as a long-term investment or burden. If your goal is more intangible, consider it as a function of your overall returns (ie. That $10,000 vacation is a reward that your portfolio purchased for you).

While these are still only a few basic examples of portfolio balancing, it illustrates how it is that you can apply your investments towards creating an investment strategy that is most relevant to you. Take a moment to think about how it is that each of these strategies could apply to a different aspect of your lifestyle or goals, and you may be able to clarify for yourself what parts of these factors are most important to your life, and how you can use them to your advantage.