It is that time of the year when many of us reflect back on the year and start thinking about how we would re-balance our portfolios. We always read about re-balancing our portfolio on various blogs or investment wisdom. Almost all of these sources show us that we should have diversified asset allocation. Now, when it comes to actually doing re balancing, that’s where, I find such resources fall short of a methodology. If I am reading any literature from investment advisory houses or brokerage firms, then I find a fixed template, which ironically remains same for everybody (albeit with some minor tweaks). I have asked few certified financial planners or advisers and almost everybody just repeats the same tape of diversification but misses on how it should be done. There is a school of thought that says sell good ones that have increased value, and buy ones that have reduced in value. Now, why should I sell something when it is consistently giving me returns (and I expect it to continue), or why should I buy something that has reduced in value. The reduced value should be an indication that something is not working, right?

In my view, the process of re-balancing is an ongoing effort. It should be always be part of investor’s ongoing buy and sell decision making process. Depending upon your investment goals and risk profile, individuals should have a set of predetermined criteria which should guide them in making buy/sell decision. This way they are proactively managing their asset allocation.

As a dividend growth investor, I have a decided a set of constraints for myself. I am a buy and hold investor as long as any given company keeps performing to my objectives. The set of constraints that I use on an ongoing basis are as follows:

1. Continuity of meeting my buying objective: Here, my attempt is to make sure that my stocks portfolio continue to meet my buying objective of dividend growth, or continued value preposition, or index exposure. Whenever, I a buy a stock, I make sure why I am buying it and how it will help my portfolio. For example, when a company cuts dividends, I sell it if it was bought for dividend growth.
2. Maintaining asset class allocation: This is related to my overall assets, ideally, which are supposed to be not related. But I always wonder in the inter-related global world, is there anything that is not related? My attempt here is to make sure, I do not over expose myself of any particular class, like REITs, emerging equity, or commodity related stocks.
3. Maintaining diversification: As a dividend investor, I believe this is a very important aspect for diversified asset allocation. Like in any other style of investing, dividends have appear to be favorable in few industry sectors such as REITs, CONROYS, consumer staples, large caps, etc. Until last year, financial sector was a darling of dividend investors. I try to limit myself up to 10% allocation in any given sector.
4. Dividends from a single stock should not exceed 5% of total dividends: 100% investing success is an illusion. Similarly, a dividends will never be cut is also a mirage. Last two years have shown us that dividends will be cut, no matter how great the company is. The only way to reduce the impact is makes sure dividends from a single company does not exceed 5% of your portfolio dividends.

It may seem that using these criteria is a cumber process. It may feel like overwhelming or over engineering. But in reality it is not so. When your buying and selling frequency is less than 24 times a year, it does not feel as a tedious process. I have discussed my risk analysis to show how a quarter reviews helps maintain a diversified allocation. It is my hope that it will minimize the down side risk in long term.

How do you perform your portfolio re-balancing?

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