The Anatomy of a Smart Investment Portfolio
When you look in the mirror, what do you see? A person who made the most of his education, who puts his efforts into rewarding, challenging work? Someone with a family to care for and a lot of life left to live – hopefully in comfort and security?
You’re not alone in wanting to make the most out of your income. What makes you unique, however, are the investment strategies that will get you where you want to be. A smart investment portfolio balances your personality and your plans with the state of the market to produce the momentum you need to watch your investments grow.
Choosing the right investment plan for your future requires a strong understanding of several tenets of investing as well as your gut feelings about each. Here’s what you need to know to build a smart investment portfolio.
Choose the Best Asset Allocation for You
At its most basic, asset allocation is the way you choose to divide your investments among various asset classes. The classic example is deciding what percentage of your retirement account is invested in stocks vs. bonds, but there are other types of investments to consider as well. Real estate and cash funds – which include your everyday banking accounts, money markets and treasury bills – are also common places where investors keep their assets.
The key to successful asset allocation lies in diversification of your investments: Spreading your money across asset classes is a smart practice to minimize your risk. If the stock market has a big decline, for example, the portion of your assets in real estate and bonds should not take the same hit and should help insulate you from some of the losses.
How should you divide up your asset allocation? There’s no "right" answer, but there are two major factors to consider:
In general, the older you are, the less investment risk you want to take. This helps you avoid taking large financial losses that you may not have time to recover from. You don’t have as much time to bounce back from a down market when you’re 75, so it makes sense as you age to gradually shift your money away from riskier areas to those with less risk. As you head into retirement, you may also want to shift your allocations to focus on investments that pay regular income, such as dividend stocks.
A general investing rule of thumb for asset allocation based on age is that investors should subtract their age from 100. The result equals the percentage of your assets that you should invest in stocks; the rest belongs in cash or bonds. For example, if you are 55 years old, 45 percent of your portfolio should be invested in stocks (100-55=45); the rest belongs in bonds. All investments carry risk but in general, stocks carry more risk than bonds or cash.
Though the general rules about age apply broadly to all types of investors, it’s also wise to take your personal risk tolerance into account. Are you the type of person who is comfortable risking large losses, or does the idea of losing your money keep you up at night? Your risk tolerance may be affected by whether you have children or a spouse as well as your expectations for your future lifestyle.
Low Risk vs. High Risk Investments
When considering your tolerance for risk, it’s a good idea to understand exactly what risk entails when it comes to investing. There are three major prongs of risk to consider:
This is the measure of the highs and lows of your investment over time. While some investments grow slowly and steadily, others may look more like a roller coaster of ups and downs.
2. Possibility of Loss
This is how likely a given investment is to fail; that is, to result in a loss of your capital. Depending on your goals, a loss may also mean significant underperformance compared to our expectations.
3. Magnitude of Loss
If your investment does poorly, how likely is it to fail catastrophically? For example, a large corporation like Walmart isn’t likely to fail, but if it does happen, would it be devastating to your portfolio?
The Pros and Cons of Low-Risk Investments
In general, low-risk investments include interest-bearing bank accounts, CDs and money market funds as well as short-term bonds and treasury bills. Benefits of these types of investments are low risk and low volatility along with high liquidity – meaning that it’s easy for you to access your cash when you need it. FDIC-insured bank accounts also guarantee your principal up to $250,000 per depositor, per insured bank, for each account ownership category.
The downside is that these investments have relatively low returns, so it will be difficult to build wealth even over long periods as you lose out on the benefits of compounding your returns over time when the interest is low.
Low-risk investments are generally good choices for short-term savings goals like a down payment on a major purchase or educational costs. They also make a good buffer to reduce your overall risk and diversify a portion of your portfolio.
The Pros and Cons of High-Risk Investments
High-risk investments come in all shapes and sizes. In general, stocks are riskier, as there’s simply no guarantee that a business will succeed, and markets are notoriously difficult to predict. Other examples of high-risk investments include; real estate investment trusts (REITs), private equity funds, venture capital funds, commodities, and trading in currencies.
High-risk investments are often more volatile and come with a bigger risk of failure. There is also no guarantee that you won’t lose your principal, as these investments are not FDIC-insured. However, in general the greater the risk, the greater the potential reward of strong returns over time.
High-risk investments perform best over the long-term and as part of a strategic investment portfolio that balances risk and employs smart asset allocation tactics.
4 Popular Investment Portfolio Strategies
To get a better sense of the type of investment portfolio that’s right for you, it’s helpful to consider some examples. Which one of these hypothetical investment strategies most closely speaks to your personality and future goals?
1. Conservative: The Least Risky
For the risk-averse – whether due to personal risk tolerance or being in or closer to retirement – a portfolio based largely on bonds could help to protect your principal and provide higher income to use during your retirement.
2. Balanced: The Most Diversified
A balanced portfolio attempts to reduce the level of risk by spreading your money across a variety of stocks, bonds, and alternative investments in order to generate moderate growth. In general, stock allocations in a balanced portfolio might be in the range from 40 to 60 percent depending on your tolerance for risk, with bonds, commodities and other investments making up the rest.
3. Dynamic: The Equally Weighted
Another way to think about your investment portfolio is to spread your risk not only among individual stocks and bonds, but across asset classes. As an example, these might include stocks, bonds, REITs, commodities and cash. An equally weighted portfolio means dividing your investments in equal percentages across the selected asset classes. For example, you might choose to have 20 percent of your money in each of the classes mentioned. Active management is required to frequently rebalance this portfolio to ensure that the desired proportion of each asset class is maintained.
4. Aggressive: The Most Dynamic
Aggressive investment portfolios are those with heavy stock investments. Additionally, aggressive portfolios often invest about 25 percent of their allocation in foreign stocks. Investors with a high tolerance for risk may also want to consider a more dynamic management strategy to sell off declining assets and purchase those on the rise.
The Anatomy of a Smart Investment Portfolio
For most people, a balanced approach is best. It helps to reduce your exposure to risk and hopefully increase your odds of solid long-term returns.
An example of a balanced portfolio would be the hypothetical "All Weather Portfolio" designed by hedge fund guru Ray Dalio and described in Tony Robbins’ book "Money Master the Game: 7 Simple Steps to Financial Freedom." According to Dalio, the All Weather Portfolio is designed to insulate investors against failures in any one sector and provide steady income with the following asset allocations:
- 30 percent in U.S. stocks
- 40 percent in long-term U.S. Treasury bonds
- 15 percent in intermediate-term U.S. Treasury bonds
- 7.50 percent in gold
- 7.50 percent in broad basket commodities
At first glance, this portfolio may look quite conservative, with only 30 percent in stocks. However, the guiding principle is that investments are diversified. Dalio uses commodities and gold, which typically increase with higher inflation. The bonds holdings, on the other hand, generally perform well while interest rates remain low.
That said, investment allocation is a highly personal practice, and what works well for one investor may leave you short of your ideal. Your own portfolio balance may be more or less actively managed or entail more or less risk, depending on your specific risk tolerance and your goals.
The Bottom Line
At the end of the day, no single investment plan will be right for every person – or even for any person in perpetuity. It’s crucial to adjust your investment strategy as you age. For example, well-known investors like Jack Bogle of Vanguard and David Swenson of Yale University recommend shifting your investments away from stocks and into less volatile bonds as you age. This can help insulate you against a bad equity market and provide some protection your principal.
How to Find the Best Financial Advisor for You
Choosing a smart investment strategy is a highly individual endeavor, and it’s one that takes time, effort, and expertise. When you find yourself overwhelmed or out of time for managing your money, it pays to choose a trusted advisor who will tailor your investments to your personal needs.
Trust Destiny Capital to work with you on developing the right investment plan for your future, whether you’re concerned about maintaining your quality of life or have big dreams for your second act when you’re finished working. With a proprietary risk management system and a personal touch, Destiny Capital is here to make managing your money and growing your wealth a team effort that fits easily into your busy schedule. With securities offered through Destiny Capital Securities Corporation, a member of FINRA/SIPC, you’ll be ready to hit the ground running when it comes to designing the right investment portfolio for you.
The content of this communication is provided for informational purposes only. It is not intended nor should it be viewed as investment advice. No one should act or refrain from acting on the basis of any information without seeking the appropriate professional counsel on his or her particular circumstances. Although every effort is made to provide accurate and useful information Destiny Capital Corporation and Destiny Capital Securities Corporation assume no legal liability for the accuracy, completeness, or usefulness of any information disclosed in this communication. Securities offered through Destiny Capital Securities Corporation, member FINRA and SIPC.