We build investment portfolios to help us reach our goals. The aim is to optimize returns and manage risk and to this end we diversify and rebalance this portfolio. Here are a few situations when our portfolios may send warning signals, for us to take corrective action.
Returns are too high
When the returns earned from a portfolio are much higher than expected, it may be a cue to check if all is well with the portfolio. The most significant reason may be that the asset allocation has shifted towards higher-earning but riskier asset classes like equity. This may mean that the portfolio is not synchronized to your needs. This can happen if you don’t track and rebalance your portfolio periodically, to ensure it is suitable to your needs. For example, a run-up in the value of an asset class with higher returns, such as equity, will make it a larger proportion of your portfolio if profits are not booked and the proportion of equity in the portfolio rationalized periodically.
Your asset allocation could also get skewed if your debt holdings have matured and the proceeds have not been re-invested in that asset class. Instead you may have increased holding in equity in anticipation of better performance. Or, interest income earned on debt holding may have been invested in equity or other higher-return products. A larger portion of the portfolio may now be in investments with volatile values and limited liquidity. This may make it difficult to redeem investments when goals have to be met. Or, you may even have to redeem at a loss.
