Change in Portfolio Proportions ⚖️🔄

A portfolio is dynamic. As stock prices change, the "proportions" (weights) of your portfolio also change. In this chapter, we look at how moving money from one asset to another changes the portfolio's DNA.

1. The Impact on Return

Portfolio return is a simple linear relationship. If you move money from a low-return asset to a high-return asset, your total expected return will increase proportionally.

Total Return = (Wa * Ra) + (Wb * Rb)

If you increase Wa (Weight of A), the total return moves closer to Ra.

2. The Impact on Risk

Unlike return, risk does not change linearly (unless correlation is +1.0). Because of diversification (correlation < 1.0), as you change proportions, the risk often drops to a "Minimum Variance" point before starting to rise again.

3. Portfolio Rebalancing

If you start with 50% Stocks and 50% Bonds, and Stocks double in price while Bonds stay flat, your new proportions might be 67% Stocks and 33% Bonds.

• Problem: You are now taking much more risk than you originally planned.
• Solution: Rebalancing. Selling some stocks and buying bonds to get back to your target proportions.

Summary

• Changing proportions changes both risk and return.
• Return changes in a straight line; Risk changes in a curve.
• The Minimum Variance Portfolio is the specific mix of assets that has the lowest possible risk.
• Rebalancing is the act of bringing a portfolio back to its target proportions.

Quiz Time! 🎯

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