If you are not paying enough attention to your investments, then the most likely problem that will build up in your portfolio is that of an unbalanced asset allocation. Let's quickly review what the concept is.
Asset allocation simply means that a certain percentage of your investments should be in fixed income and the rest in equity. For younger or more aggressive investors, the fixed income proportion could be as low as 10 per cent, but it shouldn't be zero. For those with a more conservative approach, it could be higher.
Asset rebalancing means that instead of seeing the equity-vs-fixed question as a black-vs-white binary choice, you should be seeing it as a shade of grey.
Once every year or so, you could 'rebalance' your portfolio. What this means is that if the actual balance has veered away from your desired one, you should shift money from one to the other in order to attain that initial percentage again.
When equity is growing faster than fixed income, which is what you would expect most of the time -- you would periodically sell some equity investments and invest the money in fixed income so that the balance would be restored.
When equity starts lagging -- as it has actually happened for some time now -- you periodically sell some of your fixed income investments and move it into equity.
This implements beautifully the basic idea of booking profits and investing in the beaten-down asset. Inevitably, things revert to a mean, and that means that when equity starts lagging, you have taken out some of your profits into a safe asset.
If you have been ignoring monitoring your portfolio when equity has done badly, then you may well have built up an excess of fixed income exposure unwittingly. Ideally, all this while you should be shifting money from fixed income to equity (as explained above) so that when there is a reversion to mean, then your equity exposure will help you earn more.
This is a hard idea to implement, specially because it perpetually runs counter to the basic psychological instinct of staying with what is working. Instead, it involves shifting money from the winner to the loser.
However, even if it's a difficult thing to do, it's a very powerful and useful thing to do. As it happens, this is exactly what balanced funds (or equity-oriented hybrid funds, as the category is called) do automatically and in a tax efficient manner.
All in all, regular asset rebalancing, and not blissful ignorance is the right response to the fluctuating fortunes of equity and fixed income investments.
As with the other issues that we have discussed here, the easiest way of monitoring the asset allocation of your investments is to maintain your portfolio in the Value Research Portfolio Manager.
This story is a part of our previous report about the need to monitor your portfolio in all times.