The document discusses strategies for protecting an investment portfolio from market risks. It recommends diversifying a portfolio across different asset classes through mutual funds to reduce risk. It also recommends rebalancing a portfolio periodically to restore the original asset allocation when market fluctuations cause allocations to drift. Rebalancing involves selling assets that have increased in value and buying those that have decreased, restoring the desired mix of assets. This strategy of buying low and selling high helps minimize risk over the long term.

1. Protecting Your Portfolio
Submitted by Larry Frank Sr. on Wed, 06/06/2012 - 12:00pm
How do you carve up your portfolio to minimize risk and protect it from
the market troubles, like the slump we got this spring? Through smart
asset allocation, aided by diversification and rebalancing.
Diversification means the mathematical process of reducing risk through
the use of many different types of assets. Diversification combines
stocks, bonds and other securities that are not correlated. In other
words, one asset class typically zigs while the other zags.
Asset allocation is when risk versus reward is balanced, according to the
risk capacity, risk tolerance, time frame and goals of the investor. Many
people believe that when they have more investments, it means they are
more diversified. Wrong. When allocating assets, you do two things:
1) Find asset classes that are distinct and don’t overlap. You are not as
diversified as you think if they do.
2) Examine how they interact with each other. Different classes tend to
do different things at different times.
So it is not necessarily how many pieces you have in your pie, but what
makes up the ingredients of the pieces to begin with. You have the entire
global economy to locate them. You could cut the pie into very tiny
pieces. However, those likely would be similar to other tiny pieces
nearby. A better idea: Work from the broader big picture on down, using
indexed mutual funds for defined asset classes.
Rebalancing is a management tool designed to get your portfolio back to
your original allocation target. Why? Because with time your allocation
drifts, and you take on a different risk profile as a result of this drift.
Let’s assume you are not investing in individual stocks, which may go to
zero for a complete loss. Instead you invest in index funds, which give

2. you steadier diversification. All the companies in the index would need
to go to zero for you to suffer a complete loss. Let’s also assume you
have a global asset allocation with indexed exposure to many different
asset classes.
What happens when, say, your European index fund declines and now
makes up a smaller piece of your portfolio than you want in your asset
allocation plan? Your next step is to rebalance. You sell off a portion of
your portfolio that has expanded. The next step is to buy into the asset
class that has declined. In other words, you buy more of the European
index fund.
Remember the old saying, “Buy low, sell high”? Well, rebalancing means
you are doing just that, except you sell high first, then buy low. You sell
some of what has gone up to buy more of what has gone down, thus
restoring your desired asset allocation.
This principle applies to any asset class that is shunned for the moment.
Selling winners and buying supposed losers goes against the grain
emotionally, of course. So you make this a regimen – something you
need to do when the time comes.
Note: The above strategies do not prevent a loss. They are designed to
incorporate experienced losses into a strategy that may produce some
gains if the “low” asset class recovers some. This strategy is riskier with
individual stocks because individual companies are more likely to go to,
or near, zero value than a broad-based index mutual fund.
Larry R Frank Sr., CFP, is a Registered Investment Adviser (California)
in Roseville, Calif. He is the author of the book, Wealth Odyssey. He has
an MBA with a finance concentration and B.S. cum laude in physics with
which he views the world of money dynamically. He has peer-reviewed
research published in the Journal of Financial
Planning. www.blog.BetterFinancialEducation.com.
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Topic:
Stocks
Mutual Funds
Asset Allocation