In our previous blog posts, we have discussed the importance of savings, and also some important details about the relationship between expected returns and the associated risks.
In today's post we discuss the importance of a portfolio approach and will explain you how to create an investment portfolio.
In a broad sense, our portfolios include all our assets and other assets of value. For example, our gold chains from grandma, our stamp collection from uncle, our home we own, our shares in companies, our bank accounts and our securities are all part of our wealth.
In the following, we will focus on liquid portfolio items that are easy to sell. These may include shares in listed companies, bonds, money market investments, derivatives, structured and collective investments in various individual securities, and account money. In addition to the above classic subdivisions, crypto-currencies, tokens, NFTs and virtual investments in metaverse are now an inevitable part of the portfolios of mainly younger generations.
As mentioned in our previous blog posts, it is impossible to put together a universally accepted portfolio of securities that is perfect for everyone. The investment opportunities, wealth and return expectations of an individual or family vary widely, so financial investments need to be tailored to specific situations, life circumstances and investment habits.
The construction of portfolios can be divided into three interdependent parts:
Step 1 - Checking our life situation (Liquidities, Investment goals, Risk tolerance etc.)
When it comes to investing, one size does not fit all. Every individual has their own unique life situation that affects their investment options and decisions. As a 20-year-old single person, for example, you may have more flexibility in terms of investment options compared to a 40-year-old with a family or a 60-year-old approaching retirement. Your investment goals and priorities may be different, as you may be more interested in long-term growth and capital appreciation, while someone nearing retirement may prioritize generating income and preserving their capital.
To make informed investment decisions, it is important to have a good understanding of your own financial situation, including your income, expenses, debt, and savings. You need to know how much you can comfortably afford to invest, and for how long. This requires careful budgeting and financial planning to ensure that your investment strategy aligns with your overall financial goals.
Additionally, it is important to understand your own risk tolerance. Different investments carry different levels of risk, and it is important to have a good understanding of how much risk you are willing to take on. Some investors are comfortable with high-risk, high-reward investments, while others prefer lower-risk investments that offer more stability.
To help determine your investment goals and risk tolerance, there are a variety of online investor tests and questionnaires available. These tools can provide valuable insights into your investment preferences and help you make more informed decisions about where to invest your money. We are going to publish a Blog about online investor self assessments in the next weeks. By taking the time to understand your own financial situation and investment goals, you can create a tailored investment strategy that meets your unique needs and helps you achieve your financial goals.
Step 2 - Strategic asset allocation
Strategic asset allocation is a key component of successful investing. Once you have identified your investment style and risk tolerance, it is important to decide which types of securities you want to include in your investment portfolio. This involves selecting a mix of asset classes, such as stocks, bonds, and cash, that align with your investment goals and risk tolerance.
Asset allocation is about more than just selecting a few individual stocks or bonds. It involves creating a diversified portfolio that spreads your investments across different asset classes and industries. This helps to reduce your overall risk by avoiding overexposure to any one particular investment or sector. It also allows you to take advantage of different market cycles and economic conditions, as different asset classes tend to perform differently under varying market conditions.
In addition to selecting the right asset classes, strategic asset allocation also involves setting target allocation percentages for each asset class. This requires a careful balancing of risk and reward, as different asset classes offer varying levels of risk and return. For example, stocks are generally considered higher risk but also offer the potential for higher returns, while bonds are lower risk but also offer lower returns.
Ultimately, strategic asset allocation is about creating a portfolio that is well-suited to your investment style and risk tolerance, while also providing the potential for long-term growth and stability. By taking a thoughtful and disciplined approach to asset allocation, you can build a strong investment portfolio that helps you achieve your financial goals.
Step 3 - Tactical asset allocation
Tactical asset allocation is a dynamic investment strategy that involves making short-term adjustments to an investment portfolio based on changing market conditions and economic outlook. This approach differs from strategic asset allocation, which typically involves a more static approach to portfolio construction and maintenance.
Unlike strategic asset allocation, which focuses on selecting a mix of asset classes and setting target allocation percentages, tactical asset allocation involves actively managing the portfolio by adjusting the allocation of assets based on market trends and other external factors. For example, if a particular asset class is expected to outperform in the near term, a tactical asset allocator may increase their exposure to that asset class, even if it deviates from the target allocation set during the strategic asset allocation phase.
While these two strategies may appear to be in opposition, they actually work together to create a strong investment portfolio. Strategic asset allocation provides a solid foundation for the portfolio, setting the target allocation percentages and creating a diversified mix of asset classes. Tactical asset allocation then allows for adjustments to be made to the portfolio based on changing market conditions and economic outlook, allowing the portfolio to take advantage of short-term opportunities while still maintaining the overall strategic allocation.
Strategic asset allocation is the pre-process to tactical asset allocation, as it provides the foundation for the portfolio construction. These two strategies exist together and are both important in creating a well-diversified and balanced investment portfolio that aligns with an investor's long-term goals and risk tolerance.
Real life example
Let's look at the above using my own example. As a finance-savvy man in his late 40s, I take a long-term view (over 5 years) with my investments. I am aware that higher expected returns are associated with more violent price fluctuations, but I can manage or wait these situations out. Tests and my experience over the past years also show that I can cope well with possible negative trends and temporary declines in the value of my investments, so I can also accept high-risk investments in my portfolio.
Based on the above, my strategic asset allocation contains mainly stock market equities (mainly growth-type, high dividend yielding, technology and FinTech blue chips), various private equity investments, crypto-currencies, token investments, and some liquid reserves.
When it comes to investment selection, i.e. tactical asset allocation, I choose investments that I understand well and see potential growth opportunities in them given the market environment. Since my savings are regular, I am constantly building my portfolio, making sure that each portfolio element is properly correlated.
When constructing your portfolio, make sure that you are not subject to unnecessary stress as your investments evolve. If you are not comfortable with certain market trends, change your investments and fine-tune your portfolio. Talk to informed friends and advisors about it, and your work will most certainly pay off. Remember, everyone is an investor at the end of the day and is responsible for their decisions.
Your Fortune Blog 005
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