What is your weight this year?
Portfolio weighting is the next step after being able to do diversification and allocation
Right after the holiday season, a lot of people look at their weight and see how much they have gained. The same should be done to our portfolio as well. How did it fare? And what is the next move? And for the rest of the year, how much weighting do we employ to our portfolio?
Portfolio weighting is the next step after being able to do diversification and allocation. Let us play back some of this concepts before we go in the weighting concept. First, as an investor, we need to diversify in order to manage the investment risk. This is like the cliché,
“do not put all your eggs in one basket.”
Diversification is the typical strategy. Putting aside investments into different assets is like spreading the risk. Typical assets are cash, stocks, bonds, real estate, business, etc. The next question is how much do we put into each? This is when allocation concept will have to be employed. Allocation of assets will depend on the investor’s knowledge, risk appetite, objectives, circumstances, etc. It is like a personal design based on one’s situation and preferences.
To illustrate, before the weighting concept is discussed, the following can be a typical portfolio. Say, a 1-million investment portfolio of a conservative investor could look like this:
- Cash 30 percent or P300,000
- Bonds 40 percent or P400,000
- Stocks 20 percent or P200,000
- Business 10 percent or P100,000
Diversification and allocation are then exemplified in this portfolio. After a year though, this allocation will be different from its original state as earnings will be accounted for. Say, cash placed in money market instruments earned a net of 1 percent, the bonds yielded 4 percent, the stocks gained 12 percent, and the business venture paid out a dividend of 15 percent, then the outcome will now distort the original allocation with the following weights:
- Cash 28.7 percent or P301,000
- Bonds 38.9 percent or P408,000
- Stocks 21.4 percent or P224,000
- Business 11.0 percent or P115,000
The above resulted to a total return of 4.8 percent or P48,000. So, the next prudent thing to do is bring the portfolio back to its original allocation of 30, 40, 20 and 10. This is called rebalancing. However, allocating the same amount or percentage of investments in each asset class is not exactly as prudent as one might think. Or, don’t we like to challenge ourselves a bit?
Here comes the idea of weighting. Based on analysis and observation, what if the market will perform similarly will it matter if a change in the weighting? What if one puts a little more in stocks and less in bonds and cash? Will the difference be material? This move means “underweighting” bonds and cash and “overweighting” stocks. By moving 6 percent of total from one class to the other, the difference could be significant. Therefore, for the subsequent year, the weighting is adjusted to the following: (Remember, the portfolio return is reinvested with the current value now at P1,048,000)
- Cash 27 percent or P282,000
- Bonds 36 percent or P377,000
- Stocks 26 percent or P274,000
- Business 11 percent or P115,000
Should the investment portfolio perform the same after a year, cash income is 1 percent, bond yield is 4 percent, stock gains of 12 percent and business payout of 15 percent, the following are the numbers:
- Cash 27 percent or P285,000
- Bonds 36 percent or P392,000
- Stocks 26 percent or P307,000
- Business 11 percent or P132,000
Total sum of the portfolio now stands approximately,P1,116,000 with total gains of P68,000 compared to the previous year’s P48,000. The variance is attributed to the weighting change.
So, employing the weighting concept in the investment portfolio depends on one’s market outlook and analysis of events. Based on the original weighting of 30-percent cash, 40-percent bonds, 20-percent stocks and 10-percent business, consider this as the equal weight of the portfolio. A move to put more into stocks than the usual weight is “overweighting” the stock allocation as a reflection of one’s optimism toward that asset. Conversely, by allocating less in one asset is “underweighting” that asset showing a bit of pessimism on the performance of that asset like what was shown above.
In time, doing this exercise annually makes one more sensitive to the conditions of the market and the status of the portfolio. The continued rebalancing and weighting of the portfolio attuned to the preference of the investor could not only lessen the risk, but maximize potential gains, too.
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Ricky So is a Registered Financial Planner of RFP Philippines. HE is a independent Financial Adviser of Rampver Strategic Advisors, and a Columnist of Business Mirror.
Source: http://www.businessmirror.com.ph/index.php/en/business/banking-finance/26234-what-is-your-weight-this-year
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