Your Investment Portfolio What You Need To Know About The Stock Market

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When Should You Rebalance Your Investment Portfolio?

Posted by Kevin Mercadante Last updated on October 8, 2020 | Investing
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Investment portfolios are like vegetable gardens. You have to “prune” them periodically in order to keep them healthy. You do that by rebalancing your investment portfolio.

If you use an investment manager or a robo-advisor platform to invest, you won’t ever need to worry about when to rebalance your investment portfolio. Your service will take care of everything for you.

However, if you’re a do-it-yourself investor, you’ll have to handle your portfolio maintenance yourself.

In addition to keeping your asset allocation healthy, rebalancing is the best way to take advantage of “buy low, sell high.”

When you rebalance, you buy into positions that are undervalued while selling ones that have reached their peak at the same time.

So when should you rebalance your investment portfolio? There are different ways to time it, and you can use whichever method works best for you.

Let’s take a look at some of the times when a rebalance should be in the cards.

Table of Contents

A Change in Your Risk Tolerance

While you might think your risk tolerance stays pretty much the same throughout your life, the truth is it can change due to a number of factors.

For example, your risk tolerance is likely to go down as you get closer to retirement. Fearing the loss of investment assets when you’ll soon be needing them, you might become more conservative and invest more heavily in fixed-income investments.

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By contrast, your risk tolerance might go up if you were to come into a large windfall of money.

It’s impossible to describe all of the circumstances in which your risk tolerance might change. But when it does, it’s likely you’ll need to rebalance your investment portfolio to optimize your asset allocation.

A Change in Market Conditions

Another good time to rebalance your investment portfolio is when the market makes an extreme move in either direction. (Now, know that this is controversial because it could be interpreted as an attempt to time the market.)

For example, if the stock market seems excessively high, you might want to reduce your exposure to stocks and move more money over to safer assets such as Treasury bonds.

At the opposite end of the spectrum, after a long downtrend in the market, you might be interested in rebalancing in favor of greater exposure to equities. That will give you an opportunity to earn bigger returns as the market begins to recover.

Keep in mind that, in both of these situations, you should never completely abandon either equities or fixed-income investments. However, you can change your investment allocations to be consistent with what you see happening in the market.

A Change in Life Events

Any major change in your life is likely to affect your risk tolerance and the way you allocate your portfolio.
This is another extremely broad category, since the possibilities are endless.

For example, the birth of a child might convince you to rebalance your portfolio in favor of more fixed-income investments. This way, you can reduce the overall risk in your portfolio.

However, some investors might take the exact opposite approach and invest more heavily in stocks in anticipation of higher future expenses such as education.

The onset of a major illness or the loss of your job can also cause you to take a more conservative approach to investing. You might also be more interested in fixed-income investments if you’re starting your own business, since the business itself is likely to be riskier than a steady full-time job.

And naturally, you’ll be more interested in increasing your equity holdings if your goal is to retire early.

Based on Percentage Changes in Your Portfolio Allocation

You can set certain percentage allocations in your portfolio. As they are exceeded – based on a certain predetermined percentage – you automatically rebalance.

This is probably the most common scenario for rebalancing. It also has the advantage of taking the emotion out of your rebalancing efforts. The process becomes mechanical, and emotional factors are excluded from your decisions.

You can set whatever percentage variance in your portfolio you want. For example, if you have 70% of your portfolio invested in stocks and 30% in fixed income, you might decide to rebalance anytime either allocation changes by, say, 5% or more.

In that situation, if the balance in your portfolio went to 75% stocks and 25% fixed income, you would rebalance by moving 5% of your portfolio from stocks over to fixed income.

On the flip side, were the market to drop, and stocks fall to 65% and fixed income to 35%, you would move 5% of your portfolio from fixed income into stocks.

You can set any percentage limit you like, but 5% is probably the most common. Of course, fees can be a concern here. The more frequently you rebalance, the more investment fees you’ll incur.

For that reason, you might set a higher percentage threshold, particularly if your portfolio is on the smaller side. In that situation, 10% wouldn’t be unreasonable.

At Regular Intervals

You can simply decide that you’re going to rebalance your investment portfolio based on a particular timeframe.

This is probably the simplest rebalancing strategy because it virtually eliminates emotion and even hesitation from the picture.

Rebalancing on a quarterly basis is probably the most common strategy. But if you have a very large portfolio, it may make better sense to rebalance on a monthly basis.

Again, fees are something to consider. If you rebalance too often, you’ll increase those fees.

Once again, your portfolio will be set up with certain percentage allocations that you’ll attempt to retain by periodic rebalancing. You’d make changes only if there were significant variations in your portfolio allocation.

You might even consider doing periodic rebalancing in combination with percentage changes. For example, you might plan to rebalance your portfolio on a quarterly basis, but only if there are percentage variations that exceed a certain percentage, such as 5% or 10%.

When to Rebalance Your Investment Portfolio: The Bottom Line

Rebalancing is a mission-critical part of investing and something you need to stay on top of. Pick a method that works for you and implement it as necessary.

It’s particularly easy to ignore your asset allocation when the market is flying high. But should the market reverse in a major way, you’ll be looking back and asking yourself why you didn’t rebalance your investment portfolio while you had the chance.

5 Tips for Diversifying Your Portfolio

When the market is booming, it seems almost impossible to sell a stock for any amount less than the price at which you bought it. However, since we can never be sure of what the market will do at any moment, we cannot forget the importance of a well-diversified portfolio in any market condition.

For establishing an investing strategy that tempers potential losses in a bear market, the investment community preaches the same thing the real estate market preaches for buying a house – “location, location, location.” Simply put, you should never put all your eggs in one basket. This is the central thesis on which the concept of diversification lies.

Read on to find out why diversification is important for your portfolio, and five tips to help you make smart choices.

Key Takeaways

  • Investors are warned to never put all their eggs (investments) in one basket (security or market) which is the central thesis on which the concept of diversification lies.
  • To achieve a diversified portfolio, look for asset classes that have low or negative correlations so that if one moves down the other tends to counteract it.
  • ETFs and mutual funds are easy ways to select asset classes that will diversify your portfolio but one must be aware of hidden costs and trading commissions.

What Is Diversification?

Diversification is a battle cry for many financial planners, fund managers, and individual investors alike. It is a management strategy that blends different investments in a single portfolio. The idea behind diversification is that a variety of investments will yield a higher return. It also suggests that investors will face lower risk by investing in different vehicles.

Diversifying Your Portfolio: 5 Easy Steps

Learn to Practice Disciplined Investing

Diversification is not a new concept. With the luxury of hindsight, we can sit back and critique the gyrations and reactions of the markets as they began to stumble during the dotcom crash and again during the Great Recession.

We should remember that investing is an art form, not a knee-jerk reaction, so the time to practice disciplined investing with a diversified portfolio is before diversification becomes a necessity. By the time an average investor “reacts” to the market, 80% of the damage is already done. Here, more than most places, a good offense is your best defense, and a well-diversified portfolio combined with an investment horizon over five years can weather most storms.

Here are five tips for helping you with diversification:

  • Spread the Wealth

Equities can be wonderful, but don’t put all of your money in one stock or one sector. Consider creating your own virtual mutual fund by investing in a handful of companies you know, trust and even use in your day-to-day life.

But stocks aren’t just the only thing to consider. You can also invest in commodities, exchange-traded funds (ETFs), and real estate investment trusts (REITs). And don’t just stick to your own home base. Think beyond it and go global. This way, you’ll spread your risk around, which can lead to bigger rewards.

People will argue that investing in what you know will leave the average investor too heavily retail-oriented, but knowing a company, or using its goods and services, can be a healthy and wholesome approach to this sector.

Still, don’t fall into the trap of going too far. Make sure you keep yourself to a portfolio that’s manageable. There’s no sense in investing in 100 different vehicles when you really don’t have the time or resources to keep up. Try to limit yourself to about 20 to 30 different investments.

  • Consider Index or Bond Funds

You may want to consider adding index funds or fixed-income funds to the mix. Investing in securities that track various indexes makes a wonderful long-term diversification investment for your portfolio. By adding some fixed-income solutions, you are further hedging your portfolio against market volatility and uncertainty. These funds try to match the performance of broad indexes, so rather than investing in a specific sector, they try to reflect the bond market’s value.

These funds are often come with low fees, which is another bonus. It means more money in your pocket. The management and operating costs are minimal because of what it takes to run these funds.

  • Keep Building Your Portfolio

Add to your investments on a regular basis. If you have $10,000 to invest, use dollar-cost averaging. This approach is used to help smooth out the peaks and valleys created by market volatility. The idea behind this strategy is to cut down your investment risk by investing the same amount of money over a period of time.

With dollar-cost averaging, you invest money on a regular basis into a specified portfolio of securities. Using this strategy, you’ll buy more shares when prices are low, and fewer when prices are high.

  • Know When to Get Out

Buying and holding and dollar-cost averaging are sound strategies. But just because you have your investments on autopilot doesn’t mean you should ignore the forces at work.

Stay current with your investments and stay abreast of any changes in overall market conditions. You’ll want to know what is happening to the companies you invest in. By doing so, you’ll also be able to tell when it’s time to cut your losses, sell and move on to your next investment.

  • Keep a Watchful Eye on Commissions

If you are not the trading type, understand what you are getting for the fees you are paying. Some firms charge a monthly fee, while others charge transactional fees. These can definitely add up and chip away at your bottom line.

Be aware of what you are paying and what you are getting for it. Remember, the cheapest choice is not always the best. Keep yourself updated on whether there are any changes to your fees.

The Bottom Line

Investing can and should be fun. It can be educational, informative, and rewarding. By taking a disciplined approach and using diversification, buy-and-hold and dollar-cost averaging strategies, you may find investing rewarding even in the worst of times.

How to Invest in Stocks

You can buy individual stocks or stock mutual funds yourself, or get help investing by using a robo-advisor.

At NerdWallet, we strive to help you make financial decisions with confidence. To do this, many or all of the products featured here are from our partners. However, this doesn’t influence our evaluations. Our opinions are our own.

Steps

1. Decide how you want to invest in stocks

2. Open an investing account

3. Know the difference between stocks and stock mutual funds

4. Set a budget for your stock investment

5. Start investing

Investing in stocks is an excellent way to grow wealth. But how do you actually start? Follow the steps below to learn how to invest in the stock market.

1. Decide how you want to invest in stocks

There are several ways to approach stock investing. Choose the option below that best represents how you want to invest, and how hands-on you’d like to be in picking and choosing the stocks you invest in.

“I’m the DIY type and am interested in choosing stocks and stock funds for myself.” Keep reading; this article breaks down things hands-on investors need to know. Or, if you already know the stock-buying game and just need a brokerage, see our roundup of the best online brokers .

“I know stocks can be a great investment, but I’d like someone to manage the process for me.” You may be a good candidate for a robo-advisor, a service that offers low-cost investment management. Virtually all of the major brokerage firms offer these services, which invest your money for you based on your specific goals. See our top picks for robo-advisors .

Once you have a preference in mind, you’re ready to shop for an account.

2. Open an investing account

Generally speaking, to invest in stocks, you need an investment account. For the hands-on types, this usually means a brokerage account. For those who would like a little help, opening an account through a robo-advisor is a sensible option. We break down both processes below.

An important point: Both brokers and robo-advisors allow you to open an account with very little money — we list several providers with low or no account minimum below.

THE DIY OPTION: OPENING A BROKERAGE ACCOUNT

An online brokerage account likely offers your quickest and least expensive path to buying stocks, funds and a variety of other investments. With a broker, you can open an individual retirement account, also known as an IRA — here are our top picks for IRA accounts — or you can open a taxable brokerage account if you’re already saving adequately for retirement elsewhere.

We have a guide to opening a brokerage account if you need a deep dive. You’ll want to evaluate brokers based on factors like costs (trading commissions, account fees), investment selection (look for a good selection of commission-free ETFs if you favor funds) and investor research and tools.

Below are strong options from our analysis of the best online stock brokers for stock trading: TD Ameritrade , E-Trade and Robinhood .

The passive option: Opening a robo-advisor account

A robo-advisor offers the benefits of stock investing, but doesn’t require its owner to do the legwork required to pick individual investments. Robo-advisor services provide complete investment management : These companies will ask you about your investing goals during the onboarding process and then build you a portfolio designed to achieve those aims.

This may sound expensive, but the management fees here are generally a fraction of the cost of what a human investment manager would charge: Most robo-advisors charge around 0.25% of your account balance. And yes — you can also get an IRA at a robo-advisor if you wish.

As a bonus, if you open an account at a robo-advisor, you probably needn’t read further in this article — the rest is just for those DIY types. Here are the top picks from NerdWallet’s latest robo-advisor comparison: Wealthfront , Betterment and Ellevest .

3. Know the difference between stocks and stock mutual funds

Going the DIY route? Don’t worry. Stock investing doesn’t have to be complicated. For most people, stock market investing means choosing among these two investment types:

Stock mutual funds or exchange-traded funds. These mutual funds let you purchase small pieces of many different stocks in a single transaction. Index funds and ETFs are a kind of mutual fund that track an index; for example, a Standard & Poor’s 500 fund replicates that index by buying the stock of the companies in it. When you invest in a fund, you also own small pieces of each of those companies. You can put several funds together to build a diversified portfolio. Note that stock mutual funds are also sometimes called equity mutual funds.

Individual stocks. If you’re after a specific company, you can buy a single share or a few shares as a way to dip your toe into the stock-trading waters. Building a diversified portfolio out of many individual stocks is possible, but it takes a significant investment.

The upside of stock mutual funds is that they are inherently diversified, which lessens your risk. But they’re unlikely to rise in meteoric fashion as some individual stocks might. The upside of individual stocks is that a wise pick can pay off handsomely, but the odds that any individual stock will make you rich are exceedingly slim.

For the vast majority of investors — particularly those who are investing their retirement savings — a portfolio comprised mostly of mutual funds is the clear choice.

» Still unsure which is right for you? Learn more about mutual funds

4. Set a budget for your stock investment

New investors often have two questions in this step of the process:

How much money do I need to start investing in stocks? The amount of money you need to buy an individual stock depends on how expensive the shares are. (Share prices can range from just a few dollars to a few thousand dollars.) If you want mutual funds and have a small budget, an exchange-traded fund (ETF) may be your best bet. Mutual funds often have minimums of $1,000 or more, but ETFs trade like a stock, which means you purchase them for a share price — in some cases, less than $100).

How much money should I invest in stocks? If you’re investing through funds — have we mentioned this is our preference? — you can allocate a fairly large portion of your portfolio toward stock funds, especially if you have a long time horizon. A 30-year-old investing for retirement might have 80% of his or her portfolio in stock funds; the rest would be in bond funds. Individual stocks are another story. We’d recommend keeping these to 10% or less of your investment portfolio.

» Got a small amount of cash to put to work? Here’s how to invest $500

5. Start investing

Stock investing is filled with intricate strategies and approaches, yet some of the most successful investors have done little more than stick with the basics. That generally means using funds for the bulk of your portfolio — Warren Buffett has famously said a low-cost S&P 500 index fund is the best investment most Americans can make — and choosing individual stocks only if you believe in the company’s potential for long-term growth.

If individual stocks appeal to you, learning to research stocks is worth your time. If you plan to stick primarily with funds, building a simple portfolio of broad-based, low-cost options should be your goal.

Nerd tip: If you’re tempted to open a brokerage account but need more advice on choosing the right one, see our 2020 roundup of the best brokers for stock investors. It compares today’s top online brokerages across all the metrics that matter most to investors: fees, investment selection, minimum balances to open and investor tools and resources. Read: Best online brokers for stock investors »

FAQs about how to invest in stocks

Do you have advice about investing for beginners?

All of the above guidance about investing in stocks is directed toward new investors. But if we had to pick one thing to tell every beginner investor, it would be this: Investing isn’t as hard — or complex — as it seems.

That’s because there are plenty of tools available to help you. One of the best is stock mutual funds, which are an easy and low-cost way for beginners to invest in the stock market. These funds are available within your 401(k), IRA or any taxable brokerage account. An S&P 500 fund, which effectively buys you small pieces of ownership in 500 of the largest U.S. companies, is a good place to start.

The other option, as referenced above, is a robo-advisor , which will build and manage a portfolio for you for a small fee.

Bottom line: There are plenty of beginner-friendly ways to invest, no advanced expertise required.

Can I invest if I don’t have much money?

There are two challenges to investing small amounts of money. The good news? They’re both easily conquered.

The first challenge is that many investments require a minimum. The second is that it’s hard to diversify small amounts of money. Diversification, by nature, involves spreading your money around. The less money you have, the harder it is to spread.

The solution to both is investing in stock index funds and ETFs. While mutual funds might require a $1,000 minimum or more, index fund minimums tend to be lower (and ETFs are purchased for a share price that could be lower still). Two brokers, Fidelity and Charles Schwab, offer index funds with no minimum at all. Index funds also cure the diversification issue because they hold many different stocks within a single fund.

The last thing we’ll say on this: Investing is a long-term game, so you shouldn’t invest money you might need in the short term. That includes a cash cushion for emergencies.

Are stocks a good investment for beginners?

Yes. In fact, everyone — including beginners — should be invested in stocks, as long as you’re comfortable leaving your money invested for at least five years. Why five years? That’s because it is relatively rare for the stock market to experience a downturn that lasts longer than that.

But rather than trading individual stocks, focus on stock mutual funds. With mutual funds, you can purchase a large selection of stocks within one fund.

Is it possible to build a diversified portfolio out of individual stocks instead? Sure. But doing so would be time-consuming — it takes a lot of research and know-how to manage a portfolio. Stock mutual funds — including index funds and ETFs — do that work for you.

» Which is the better investment? Stocks vs. real estate

What are the best stock market investments?

In our view, the best stock market investments are low-cost mutual funds, like index funds and ETFs. By purchasing these instead of individual stocks, you can buy a big chunk of the stock market in one transaction.

Index funds and ETFs track a benchmark — for example, the S&P 500 or the Dow Jones Industrial Average — which means your fund’s performance will mirror that benchmark’s performance. If you’re invested in an S&P 500 index fund and the S&P 500 is up, your investment will be, too.

That means you won’t beat the market — but it also means the market won’t beat you. Investors who trade individual stocks instead of funds often underperform the market over the long term.

How should I decide where to invest money?

The answer to where to invest really comes down to two things: the time horizon for your goals, and how much risk you’re willing to take.

Let’s tackle time horizon first: If you’re investing for a far-off goal, like retirement, you should be invested primarily in stocks (again, we recommend you do that through mutual funds).

Investing in stocks will allow your money to grow and outpace inflation over time. As your goal gets closer, you can slowly start to dial back your stock allocation and add in more bonds, which are generally safer investments.

On the other hand, if you’re investing for a short-term goal — less than five years — you likely don’t want to be invested in stocks at all. Consider these short-term investments instead.

Finally, the other factor: risk tolerance. The stock market goes up and down, and if you’re prone to panicking when it does the latter, you’re better off investing slightly more conservatively, with a lighter allocation to stocks. Not sure? We have a risk tolerance quiz — and more information about how to make this decision — in our article about what to invest in .

What stocks should I invest in?

Cue the broken record: Our recommendation is to invest in many stocks through a stock mutual fund, index fund or ETF — for example, an S&P 500 index fund that holds all the stocks in the S&P 500.

If you’re after the thrill of picking stocks, though, that likely won’t deliver. You can scratch that itch and keep your shirt by dedicating 10% or less of your portfolio to individual stocks. Which ones? Check out our list of the best stocks , based on year-to-date performance, for ideas.

Is stock trading for beginners?

While stocks are great for beginner investors, the “trading” part of this proposition is probably not. Maybe we’ve already gotten this point across, but to reiterate: We highly recommend a buy-and-hold strategy using stock mutual funds.

That’s precisely the opposite of stock trading, which involves dedication and a great deal of research. Stock traders attempt to time the market in search of opportunities to buy low and sell high.

Just to be clear: The goal of any investor is to buy low and sell high. But history tells us you’re likely to do that if you hold on to a diversified investment — like a mutual fund — over the long term. No active trading required.

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