Creating an Investment Portfolio Formula

Risk versus Returns

This concept provides the foundation of investment strategy. In this area you will need to take on enough risk to ensure your portfolio grows sufficiently, but if you take on too much risk, the money may not be there when you need it. An understanding of asset categories, risk tolerance and diversification is necessary to come up with the right formula for your situation.

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Asset Categories

The three most common asset categories are equities, fixed income and cash. Each category has different levels of potential returns and inherent risks, and each will perform differently in specific market conditions. Most of the growth in your portfolio will come from investments in the stock market. The stock market is also the most volatile investment, which makes short term investing quite risky.

Asset allocation is dividing your investments between these asset categories and will provide some diversification in your portfolio. Some investors may want to include other asset categories such as commodities, real estate, private equity or precious metals. Each of these has its own inherent risk and your financial advisor will take those into consideration if they are a part of your portfolio.

Asset Allocation Formula

There is no one right formula for asset allocation but it is a critical component of your financial plan. Your Financial Advisor will recommend an ideal asset allocation formula for your portfolio that is based on your risk tolerance, investment horizon and financial goals. This formula is equally, or more important, than the actual selection of investments. Your asset allocation formula should be reviewed and possibly changed whenever there is a change in your risk tolerance, your goals, or financial situation.

Risk Tolerance

Your risk tolerance is based on two factors; the first is your willingness or ability to lose some or all of your investments in exchange for potentially higher returns. The second factor is your investment horizon – how many years or decades do you have to achieve your financial goals. An investor with a longer investment horizon may be more comfortable investing in more volatile investments as they can wait out the inevitable ups and downs of the markets. Investors who are closer to the achievement of their goals will want to move their money into lower risk assets.


The concept of diversification is as simple as “don't put all your eggs in one basket”. Different companies and industries will perform differently under various market conditions. Through the selection of a variety of investments across asset categories and industries you can mitigate risks without forfeiting too much potential gain.

A well balanced portfolio is diversified not only between asset categories (equities, fixed income and cash) but also represents a wide range of industries within those asset categories. This will ensure your portfolio isn't positively correlated to any market. A high quantity of investments will not necessarily ensure diversification.


Some investments will grow faster than others, which can skew your asset allocation formula. For example, if your stock investments should represent 70% of your portfolio but recent market trends have lowered the value of your equities to 60%, you should rebalance. In order to return to your ideal formula, you may decide to decrease your fixed income or cash investments or purchase more stock investments. Part of the rebalancing process will include reviewing the investments in each category to ensure they are in alignment with your investment goals. Rebalancing can be accomplished via two methods:

  • By selling investments in over-weighted categories and using the proceeds to purchase investments in under-weighted categories;
  • By purchasing investments from under-weighted categories, either through a one time purchase or by changing instructions for regular contributions until balance is restored.

The method of balancing may have tax consequences or trigger transaction fees, which will be taken into consideration by your financial advisor.  Rebalancing should be done only when the relative weight of an asset class has increased or decreased more than a specified percentage.

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  • Team

    Bircher Financial

    For over 20 years Bonnie Bircher and associates have guided clients through every aspect of their financial life. From investing and saving to retirement and estate planning, Bircher takes pride in offering the highest levels of service and ethics.