In finance, a portfolio consists of several investments of cash, stock, bonds and other tradable commodities. One of the keys to successful long-term investment is diversification: owning a range of many different types of commodities, so if one happens to perform poorly, your portfolio loss isn't absolute.
Diversification helps balance out the risk of any given investment. In addition, it allows your portfolio to reflect your own needs, timing and tolerance for risk. Most individual portfolios focus on stocks and bonds, often in the form of mutual funds, and there's plenty of advice to be found on what sort of breakdown, or portfolio weighting, your portfolio needs to have.
How to Calculate Portfolio Weight
You may want to look at your balance to see whether your investments are heavily weighted in one or two areas. To do this, you'll need to know the total value of your portfolio, as well as the value of each investment you have within that portfolio. An investment's weight is simply the percentage of your total portfolio represented by that investment.
For instance, if your total portfolio is worth $10,000, and you have $3,500 in Stock A and $1,000 in Stock B, Stock A is 35 percent of your portfolio, whereas Stock B is 10 percent. This means changes in A will affect your overall portfolio more than changes in B.
You can also calculate the weight of an investment in your portfolio based on the number of shares of stock, rather than its worth in dollars. For the above example, let's say you own 100 shares of stock total; 20 of them are in Stock A and 20 are in Stock B. Each of these will be 20 percent of your portfolio by share in the weight of stock formula. This portfolio weighting can help you maintain your chosen investment profile.
Why Portfolio Weighting?
The investments that make up your portfolio are likely to change over time. This isn't just because the market changes; individual needs change over time, as well. For example, a young individual just entering the workforce may be able to accept more risk, since they won't expect to use their investments for years.
On the other hand, an older individual looking to retire will want to dial down their risk to keep their invested money safe. Keeping track of your portfolio mix is the best way to ensure you have the right balance of cash, bonds, stocks and other commodities for your needs, writes the team at Fidelity. Portfolio weighting is a great way to ensure you stay on track.
Weighted Investment Targets
Usually, when you start investing, you determine your own portfolio targets initially and adjust your investments to keep the balance in your risk tolerance zone. For example, some investors prefer to maintain a high percentage of stock investments, since higher risk means higher potential return. Others may choose to have no more than 20 percent of their total portfolio value in any single investment.
Constructing guidelines like this will help you adjust the portfolio as the market changes around you. Suppose one of your investments grows to be a larger portion of your portfolio over time. In that case, it's a sign that you need to look into the situation and adjust either the existing investments or your expectations.
Understanding weighted investment mixes will also help your knowledge of mutual funds, which are selected groups of stock and other investments meant to represent a particular blend of commodities. Many find it easier to invest in these blended funds, as they're already diversified.
Consider also: Example of a Well Diversified Portfolio