Strategies of the successful investor part 4: Rebalancing

One of the most important aspect of your investing life is rebalancing. As you know a portfolio must be diversified in that the portfolio is composed of a wide variety of asset types such as bonds, stocks, etc. Depending on your investment plan and your risk tolerance the different asset classes will be a certain percentage of the portfolio. And in each asset class their would also be some diversification.

You would probably have stocks that are in different sectors of the economy or bonds that are from different types of issuers such as corporate bonds, municipal bonds or government bonds.

Hence it is important that your portfolio composition be as close as possible to that that your plan states. However the economy is not static. Depending on the state of the economy some stocks might increase in value while others decrease in value. This will cause your exposure to these sectors to change. The percentage of the stocks of some sectors of the economy will increase or decrease in your portfolio.

The change in price might also change your exposure to some asset classes. A bull market might increase the percentage of stocks in your portfolio while reducing the percentage of bonds in your portfolio. If left unchecked the asset allocation of your portfolio will change with time and also the riskiness of your portfolio will change. This might thus reduce your chance of reaching your goals.

Thus you need to rebalance regularly. At least once a year is sufficient. Your aim is to reduce your exposure to certain asset classes that have increased in value while increasing your exposure to those that has decreased in value. You will thus return your asset allocation to that that is stated in your investment plan.

You will thus have to sell securities and buy others. This is the most difficult part for some investors because of the cost involved in selling and buying securities. Also some investors may not like selling performing stocks and buying poor performing stocks. However history tells us that a portfolio left to fluctuate with the market always perform poorly.

So keep rebalancing and your portfolio and you will be on course to riches.  

What are treasury bills?

Treasury bills is one type of instruments that is traded in the money market. 

A treasury bill is typically a bond that is issued by a central bank or by a government that has a maturity of less that one year. The treasury bill is sold without coupon payment. A coupon is a payment that is made every six month. It is paid as a percentage of the nominal price of the bond.Hence the treasury bill is sold at a discount and then the government will pay the face value at maturity.

These treasury bills are issued by governments in order to raise funds from the market. Because these bonds are issued by the government of a country it is therefore considered to be the safest asset and as a result would have the lowest return of all. Because of its safety it is used very often to calculate the bond spread of other bonds. The bond spread is simply the difference in return between the other bond and the return on a three month treasury bill. The greater the bond spread the riskier the bonds.

Treasury bills are also the most liquid and the most traded of all instruments. This is mainly because banks and other non-bank financial companies are required by law to hold them. For banks they may be used as collaterals in repo transactions with the central banks or in the interbank market to obtain funds. Because they are highly liquid these institutions hold them so that they can be readily converted to cash to settle obligations. Otherwise if they have excess funds they invest them in treasury bill in order to get a decent return. Short term insurers also hold a significant amount of treasury bills because they also need to have access to their fund on short notice.

These treasury bills are issued in two ways. They are either issued through auctions or over the counter. Banks and other institutions participate in weekly auctions. They state the price, the discount rate and the maturity that they want and the central banks will allocate the bills starting from the one offering the highest offered price. After they are issued in the primary market they can then be sold in the secondary market where you can buy them. However you can still buy them directly from the central bank.

As an investor you might obtain treasury bills at any institutions that have them in their portfolio and are prepared to sell them or over the counter at the central bank. But I would strongly advise investing in a money market fund if you want to gain exposure to the money market.

However since treasury bills are the safest of all investment it makes no sense investing a lot of money in them. At best you can invest 5 to 10 % in them in case you want to diversify your portfolio and decrease the riskiness of your portfolio. I would myself advise about 10% in a money market mutual fund, 10% in a bond mutual fund and the rest in other instruments such as gold, stocks, and so on.    

Strategies of the successful investor Part 1: Set up a plan

This is the first part of a series of post which would be about the strategies of the successful investor. As we have previously discussed the only way to be secured financially is through investing. However there are some very important things the the beginner investor must keep in mind so that his portfolio will grow with time.

A plan is the cornerstone of your investing journey. The plan is simply a document that would guide you and make sure that you do not get off-track.

It contains firstly your objectives.Each person may have different objectives and to state them clearly and the time available is crucial to your plan. You may want to retire in 35 years or to send your child to college.

After having written your objectives you would thus try to determine the amount of money that would be required to achieve these objectives.

After having identified your objectives and the money that would be needed, you would then be able to identify the return that would be required to reach that amount of money. Your portfolio will thus have to have a certain annual return so that you will be able to reach that objectives. If you cannot reach that return then you would be unable to achieve your objectives.

However the return is also related to another term and that is your risk tolerance. This is related to the different component of your portfolio and the return of your portfolio. You have to understand that some investment instruments are risky in that you can lose your money especially if the company go bankrupt but if you can hold on to it and the company stays afloat you would have greater return. The higher the riskiness and the greater the return. Some people have a low tolerance and as a result would want safe assets. However safe assets would result in low return. Hence if you want higher return you would have to invest in riskier assets.

After having chosen the return that you want and the risk that you are prepared to tolerate you would thus be able to choose the investment instruments that you need to invest in to achieve the return that you want.