Whether you believe in buying and holding an asset for the long term, or you seek the thrill of huge returns, most investors go into the game with the same goal in mind: to minimize overt risk while maximizing potential profits.

One of the best ways to do this is through a balanced portfolio.

A balanced investment strategy is one that focuses equally on risk and potential reward. It does this by balancing between aggressive growth with capital preservation strategies.

But how do you know if your portfolio is properly balanced?

What makes for a ‘balanced’ portfolio?

As with any aspect of investing, there’s no hard and fast definition of a balanced portfolio. What it looks like will depend on your particular investor profile: your strategy, risk tolerance, and time horizon. The balance is where you feel most comfortable weighing all of those different factors.

Every investor is unique, so you need to tailor your balanced investment strategy to fit your specific needs.

For example, an investor focused on safety and income might weigh their portfolio more heavily with high-grade government bonds, money market instruments, certificates of deposit (CDs), and blue chip stocks that pay solid dividends. (If you’re not familiar with the term, a blue chip company has several characteristics, but for our purposes, it’s a large, established, financially stable company with an excellent reputation.)

Meanwhile, investors focused on greater yields in the short term might prefer to put more weight in growth stocks and lower-quality corporate bonds that boast higher coupon rates.

If you’re a middle-of-the-road investor you’d want to look at balancing your portfolio across these two strategies. For instance, you might want a portfolio that includes equal amounts of high-grade government bonds, mid-grade corporate bonds, dividend-paying blue chip stocks, and small-cap growth stocks.

The idea is to tread the line between capital preservation and return on investment.

How do balanced portfolios work?

Regardless of what your specific portfolio looks like, it’s likely to be largely spread across three main asset classes: stocks (equities), bonds, and cash.

You may want to consider other asset classes as well, such as real estate investment trusts (REITs), emerging markets, and precious metals. But any strong portfolio should consist at least of a mixture of these three main asset classes.

Each type of asset provides its own benefits.

  • Stocks tend to be riskier, but generally provide greater potential returns

  • Bonds generally don’t offer huge growth potential, but they safely deliver fixed income

  • And cash, while offering no return, also offers zero risk – cash on hand won’t grow or shrink. (It’s worth noting that inflation can lower the value of your dollars, so it’s wise to keep cash in a high-interest savings account.)

So investing across asset classes lets you partake in the benefits of each, while also balancing your risk.

More importantly, though, these asset classes tend to have zero, or even negative correlation. Correlation is the measure of how assets move in conjunction with each other. High correlation means that assets are likely to move together, no correlation means there’s no connection between their movements, and negative correlation means they tend to move in opposite directions.

Investing in highly correlated assets makes for a weaker portfolio.

For instance, if you were to invest all of your money into the stock market, any market volatility (or worse, a crash) would put your entire portfolio at risk.

On the other hand, being invested solely in bonds isn’t ideal either, as you would miss the higher rewards offered by equities.

Because the stock and bond markets have low correlation, investing across both assets means that any movement in one is unlikely to affect the other. So your bond holdings will cushion the risk of your stock holdings, while your stock holdings provide better returns.

Building a balanced portfolio

While no one can tell you exactly how to balance your portfolio, there are widely accepted guidelines depending on your specific circumstances.

For instance, if you’re just starting out and have time on your side, you might have a greater tolerance to short-term risk, and could lean into more of a growth strategy, investing more of your capital into riskier stocks with greater upside potential.

On the other hand, if you’re nearing retirement or are otherwise relying on your investments for direct income, you’ll probably want to err more heavily on the side of safety, with more invested in cash, bonds, and money market instruments.

When building (or restructuring) your portfolio to be balanced, you’ll want to consider:

  • Your income needs, your savings needs, and any other investment goals you may have

  • How long you plan to be invested

  • How much you’re willing to risk and still sleep at night.

One of the simplest ways to build a balanced, diversified portfolio is by buying index funds (baskets of holdings that match specific market indices, like the S&P 500). This way, you’re getting all the benefits of a variety of holdings, without having to manage any of them individually yourself. There are exchange-traded funds (ETFs) and mutual funds for nearly every market.

Finally, you’ll want to consider rebalancing your portfolio. For example, say you start with a 60/40 division between stocks and bonds. But your stock holdings increase in value, while your bond holdings remain steady. Suddenly, your portfolio now represents 80% stocks and 20% bonds. In this case, you may want to consider moving some of your capital out of stocks and back into bond investments in order to rebalance to the 60/40 ratio.

There is some debate surrounding the efficacy of rebalancing. Some experts question the logic of selling assets that are performing well to achieve balance. Others argue that maintaining balance is the key to mitigating risk and maximizing return.

Once again, as with all other things investing, you’ll have to decide what’s right for you, and tailor your personal approach.

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