How much is enough?

A question came up the other day, someone said "when you are balancing your portfolio to spread the risk adequately how much balancing is enough"? “And how do you know that the risk is spread enough to adequately cover your investments from the ravages of the market and the overall economy”? As always the views expressed here are my own peculiar views of risk versus reward and balance versus imbalance in my own portfolio..

My experience stems from years of sweating over the same issues and questions, The question, how to come up with a balancing act that spreads the risk so that your capital is protected and without limiting your profits is always a tough nut to get around. There are probably as many views of risk spreading as there are people that invest. Some times the risk can be reduced by spreading investments across many key sectors or by investing in a different type of instrument such as tax exempts or specialized Exchange Traded Funds that dominate one particular sector which may have a solid history of weathering bad times. Other times risk spreading can be safely done by investing in a set percentage of large, mid sized and small cap funds. Some times a balanced portfolio of mutual funds from some of the industry leaders can spread risk and help to ride out the economic hiccups that always seem to occur. But I think there is more to risk spreading then these old standard formula responses. I’ll elaborate a little further on.

Not to be philosophic, but, I have always had the view that a portfolio was a work in progress, constantly shifting sometimes shrinking but always with some motion attending it. I see the portfolio almost as a viable entity sort of like a orchard that requires careful pruning over time, removing the dead wood of investments that do not meet your expectations or fail in some way and nourishing the green shoots of the stocks, bonds, mutuals, tax exempts, and Exchange Traded Funds that might make up your capital investments. The careful pruning of the investments that failed to meet your overall requirements is a definite must but unfortunately all too often we think that our broker will be watching over the health of our investments when indeed no one is watching. I believe many times we purchase a stock or mutual fund and then it seems to slide into oblivion as time passes. If we review on a annual basis the investments are reviewed and maybe changes made perhaps later after the stock has already begun to slide.. That risk is one that we don’t anticipate . The downside is that the investment can grow worse until it weighs down in your portfolio causing its own imbalance.

Age I think is one of the main points that effects risk when you begin investing and maybe sets the tone for how risk is used to balance your portfolio. Why your age? Because your age is one of the main drivers for your portfolio. At a younger age when you are starting out, when you are in your 20s risk can be more easily assumed and in fact a higher level of risk is acceptable to begin your portfolio. My definition of risk at this time is not taking a flyer on the pink sheets (Penny Stocks) nor is it gambling on questionable moves by very high-risk stocks. What I would consider reasonable risk applied to your beginning portfolio would be, deliberately establishing an imbalance in your portfolio by investing in NASDAQ stocks that although established companies still can move suddenly within their sector on adverse reports rather than the more established stocks of the NYSE. The reason being that this time for you should be one of increasing your portfolio worth through acceptable risk At the age of 20 to 30 your stocks would be a mixture of 50-60% NASDAQ’s with the remaining taken up by a large-cap stock as a stabilizing anchor and a mutual to round out the portfolio. I think that the definition of acceptable risk at that earlier age becomes a matter of what you can safely do to enhance your portfolio value through judicious investing without crossing the line of bad investing for the lure of what might be investments that sound too good to be true.

Progressing in age to the 30s, the volatile types of stocks from the NASDAQ should be rolled over into the more established large caps with also an increase of mutuals.and perhaps a beginning investment in municipals for the tax exempt status and protection. Risk thus changes with oncoming age. What was acceptable through the 20s by 30 is beginning to be changed to a balanced type of stock picking that reflects a more mature and safer outlook conserving your capital. The earlier risk ventures are no longer what you want nor can afford especially for your 40s and 50s.. Each decade then moves you away from the earlier risks that were acceptable to these new risk levels that taken incrementally do not overwhelm your more stable portfolio. In the later decades, you switch to more solid types of investments, NYSE, because your motives are now Conservation of Capital rather then a higher degree of risk to build capital...Age then becomes almost the sole arbiter of how much risk is acceptable and how you are going to spread that acceptable risk over the portfolio.

In summary, if you follow any type of investment formula related to your age and financial condition and have already begun investing using those formulas then you should be adequately covered for the risks of market and economic storms. There are obviously no way that you can protect all your investments from all catastrophes. But having maximized your portfolio to the level which you financially could do will insure that your protection goes a long way as well. My final word, how much is enough? If you balance your investments over a few NASDAQ sectors, NYSE sectors and finish with either mutuals and munis, then you’re as good as you can get.

My portfolio for my age of 70 has 20% NASDAQ , 70% NYSE (big caps), and mutuals and municipals. I’m conservative.

Jim Cone is a retired RN and Hospital Administrator and has a keen interest in all aspects of finance and basic investing. He can be found at his website, http://www.diversified-investor.com