Building a Profitable Portfolio #4

Step 4: Rebalancing Strategically

Once you have determined which securities you need to reduce and by how much, decide which underweighted securities you will buy with the proceeds from selling the over weighted securities.

To choose your securities, use the approaches discussed in Step 2.

When selling assets to rebalance your portfolio, take a moment to consider the tax implications of readjusting your portfolio.

Perhaps your investment in growth stocks has appreciated strongly over the past year, but if you were to sell all of your equity positions to rebalance your portfolio, you may incur significant capital gains taxes.

In this case, it might be more beneficial to simply not contribute any new funds to that asset class in the future while continuing to contribute to other asset classes.

This will reduce your growth stocks' weighting in your portfolio over time without incurring capital gains taxes.

At the same time, always consider the outlook of your securities. If you suspect that those same over weighted growth stocks are ominously ready to fall, you may want to sell in spite of the tax implications.

Analyst opinions and research reports can be useful tools to help gauge the outlook for your holdings. And tax-loss selling is a strategy you can apply to reduce tax implications.

Remember the Importance of Diversification

Throughout the entire portfolio construction process, it is vital that you remember to maintain your diversification above all else.

It is not enough simply to own securities from each asset class; you must also diversify within each class. Ensure that your holdings within a given asset class are spread across an array of subclasses and industry sectors.

As we mentioned, investors can achieve excellent diversification by using mutual funds and ETFs.

These investment vehicles allow individual investors to obtain the economies of scale that large fund managers enjoy, which the average person would not be able to achieve with a small amount of money.

The Bottom Line

Overall, a well-diversified portfolio is your best bet for consistent long-term growth of your investments. It protects your assets from the risks of large declines and structural changes in the economy over time.

Monitor the diversification of your portfolio, making adjustments when necessary, and you will greatly increase your chances of long-term financial success.

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