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Chapter 19 — Foreign Composition and Investment Timing
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Foreign Composition and Investment Timing

Foreign Composition and Investment Timing

Portfolio balancing and dollar cost averaging are two important factors or methods to consider when you are looking at your investment options.

a. Balancing and Rebalancing

Balancing or “weighting” your portfolio can be tricky. For example, assume that you are an aggressive investor who wants to be 100% invested in stocks and has found 5 suitable investments. You could distribute the cash evenly and put 20% of your portfolio into each investment, or you could load up on the investment with the most favorable potential return and put as much as 50% of your portfolio into your best idea. You are less likely to be hurt by mistakes when you distribute your cash evenly, but under ideal conditions, you will do better when concentrating on your best idea. Famous investors have been successful using both strategies.

Even when you have the balance of investments that you want, your portfolio will naturally shift as some investments do better than others. When this happens, you can choose to let the portfolio evolve naturally, “rebalance” periodically, or set limits for your portfolio’s balance and let the portfolio fluctuate within those limits.

There is no easy answer on when to rebalance your portfolio. More active investors will often choose to rebalance their portfolio by selling investments that have done well and rebalancing with other investments. More passive investors will either allow the portfolio to fluctuate within set limits or not rebalance at all. Overall, rebalancing is a matter of personal preference, but it is worth keeping in mind that many wealthy investors became wealthy by allowing their best ideas to grow instead of rebalancing their portfolio into other investments.

b. Dollar Cost Averaging

There is a common concern about whether to invest your funds all at once or to build investment positions more slowly. In theory, you could potentially time the market correctly with a lump sum investment, but in practice, every professional investor uses some form of dollar cost averaging.

Dollar cost averaging is a way to mitigate the impact of market timing. For example, if you have $5,000 that you want to put into a single investment, you could invest all $5,000 at once, or you could buy stock with installments of $1,000 every week or every month. If you invest slowly while the stock price is declining, your average cost for the stock will also be declining. However, with very small amounts of money, the cost of commissions might be too high to make this strategy worthwhile.

Dollar cost averaging can also be used as you make contributions to your portfolio. You can do this naturally by depositing the same amount of money each month. Each deposit will buy fewer shares during boom markets but will buy more shares during down markets. It will also give you cash available that you can invest later if you don’t have any good investment ideas. However you decide to use your cash, a hard rule should be to never stop contributing because you never know when that cash will become useful.