Security markets are volatile and can produce a sudden boom or bust. If you’re investing in one asset class, sudden busts become a painful lesson in the perks of diversification. The saying “never put all your eggs into one basket” starts ringing around in your head. Strategies to diversify your stock portfolio will help spread your investments in uncorrelated markets. For example, by separating your 10 eggs into 10 different baskets. If one basket of assets is particularly volatile at a point in time, the other baskets should balance the portfolio out.
HOW & WHY TO START YOUR STOCK PORTFOLIO
By buying shares in companies, you give yourself the opportunity to grow your money. The growth will mirror the growth of those specific companies as well as the broader economy they operate in. It’s a superior approach to ensuring your savings outperform general inflation. Furthermore, you can start with as little as 100 pounds or 25 pounds a month. This approach enables you to put your money to work as soon as you save it. Stocks are very liquid, meaning you can withdraw them at any time. Although this instant access creates increased volatility and the ability to let emotions get in the way of decisions. The stock market provides an opportunity to buy assets at the touch of a button through investment platforms that act as an investment supermarket.
THINGS TO CONSIDER BEFORE ESTABLISHING YOUR STOCK PORTFOLIO
When establishing your securities allocation and how that’s going to complement your wider investment portfolio, you need to be radically truthful with yourself regarding the following aspects:
Your current financial position: this includes the cash you’re holding in the bank, your current investments, and also your ability to save and invest from your monthly salary.
Time period you’re looking to invest for: if you’re older and gearing up for retirement or planning to use the money for a house deposit in 2 years’ time, you have less time to weather significant volatility. If you have a longer time horizon, volatility is easier to stomach as you have time to even out returns.
Your psychological risk capacity: this is hard to establish if you’ve never watched your money drop into the red. Establishing your tolerance for risk is key to maintaining a certain strategy. It all stems from being able to hold your nerve. Moreover, the ability to be consistent with a plan from month to month and not make rash decisions due to the market. Risk management helps you sleep at night, so being truthful with yourself from the start will help you have peaceful sleep.
Available time to action the plan: this relates to the amount of time you have in the day or month to research investment ideas and dictates whether you’re able to be an active or passive investor. If you have a busy lifestyle, a full-time job, kids, and a full-on social calendar. With all the will in the world, finding time consistently to actively research investments is going to be tough. The recommendation would be that the automated passive approach would suit the best. Whereas someone without the commitments could consistently allocate time to carry out more active strategies.
THE ADVANTAGES OF DIVERSIFYING YOUR STOCK PORTFOLIO
It is a risk management strategy; by diversifying your portfolio into non-correlated assets, it decreases the volatility of your portfolio. Different assets within a diversified portfolio rise and fall in differing market conditions. This results in more constant returns for the portfolio as a whole over time. The main advantage of diversification is the effect it has on your investment psyche. For example, a diversified portfolio in a recession may drop 10%, which is relatively palatable. Whereas a few undiversified stocks, which may drop 40%, would be very tough to recover from. The aim of the game is not to be forced emotionally or by liquidity to sell in bad times and lock in losses. Through diversification, it limits the downturn and enables you to sleep better. Moreover, it doesn’t impede your ability to achieve growth in good times.
DIVERSIFY YOUR STOCK PORTFOLIO THROUGH FUND INVESTENTS
Ready-made funds give investors access to a vast number of equities, bonds, or commodities. They are all pre-allocated in a portfolio to gain exposure to a specific asset class in the market. They’re an excellent method to diversify without complicating things. Moreover, funds are easy to automate for monthly investment, reducing the continual time commitment. Each investor receives gains or losses in value as well as a dividend that reflects their investment in the fund. Ready-made funds come in a couple of forms:
Mutual Funds: Mutual funds give investors access to portfolios that professionals manage. The professionals manage these actively and strive to achieve above-market returns. Mutual fund fees are significant due to the active management of professionals; these fees can range from 0.75% to 2.5%.
Index Funds: Index funds mirror a major market index such as the S&P 500. This strategy requires less research from analysts and advisors as the funds just track a specific market. By tracking the market, it results in fewer expenses for shareholders. The fees are in the range of 0.05% to 0.15%.
Performance comparison index funds Vs. mutual funds
The big question is whether the extra fees are worth it. In Tony Robbins’ book Money Master the Game, he points out that 96% of actively managed mutual funds fail to beat the market over any sustained period of time. thus giving mediocre results when considering the fees involved. In David Swensen’s book Pioneering Portfolio Management, he details that index funds are vastly superior when looking at the previous track record of developed and developing markets. There are some markets that are worth active management, such as private equity and venture capital. Although access to these products for the everyday investor is hard and suits institutions or the UHNW.
VALUE INVESTING STRATEGies FOR YOUR STOCK PORTFOLIO
This includes the research and buying of individual stocks. This is termed the value investing approach pioneered by Benjamin Graham in his book, The Intelligent Investor. This was taken to new heights by Warren Buffett, one of the most successful value investors of all time.
Value investing is the long-term investment in a number of quality companies bought at bargain prices. Value investors invest in quality stocks when they are trading for less than their intrinsic or book value due to the market underestimating their worth. This method requires a detailed understanding of financial statements, the ability to conduct financial analysis, and the time available to actively research the market and individual stocks. This is an active approach to stock investing and comes with increased risk. Conventional thinking would suggest that by concentrating on the companies you invest in, it creates less diversification and more risk. With the necessary due diligence, you can create precise diversification through location, size, and industry with a selection of well-priced companies. Executing this strategy, like Warren Buffett, has proven highly effective and can provide very appealing returns.
DIVERSIFYING YOUR INVESTMENT PORTFOLIO STRATEGIES
Funds provide great diversification within an asset class, although diversifying across asset classes is just as important in a securities portfolio. Below are some examples of diversifying within your stock portfolio:
Industry: investing across a range of industries gives broad exposure to the market. It prevents overexposure to a specific industry if an event stimulates an industry downturn, such as the tech bubble in 2000.
Geography: gathering a mix of locations covers you if a specific region struggles economically. An easy way to be diversified is to invest in global funds. These have inbuilt geography diversification, although they will be biassed towards the strongest economies, such as the US.
Size of companies: these are termed large-cap, medium-cap, and small-cap companies. The various sizes of companies perform differently in each phase of the business cycle. For example, large-cap companies are known to be more stable and less vulnerable to share price volatility. Whereas small-cap companies are riskier and more inclined to volatility but offer greater growth potential.
Developed and emerging markets: having a balance of developed and emerging economies gives good risk and return qualities to your portfolio. Emerging markets are economies that are developing and experience rapid growth as well as great volatility. Developed countries are established and provide more predictable volatility. The highest returns are found in the fastest-growing economies, although when adding emerging markets to your portfolio, limit yourself to managing against significant fluctuations.
Time of purchase: by continually investing automatically in your portfolio on a monthly or quarterly basis. You can smooth out the ups and downs created through market volatility by buying at every stage of the market. This reduces your investment risk as you average your entry points to the market’s performance over time instead of trying to time the market at a precise point in time, which is proven to be a hard strategy to continually win over time.
Asset allocation: In a security portfolio, allocating a variety of assets gives great diversification. Assets like bonds and stocks are most common, although alternative assets such as commodities, private equity, REITs, and venture capital, which have been shown in the analysis of Endowment Funds are significantly used by institutional investors to generate diversification in their portfolios.
SUMMARY
Whether you construct a portfolio similar to the Church Commissioner’s or Yale portfolio, or even if you’re confident enough to follow a value investing approach, it needs to suit your personal goals. This can be established by answering the initial consideration questions above. The main and underlying benefit of security investment is the power of compound interest, and the earlier you start, the earlier you take advantage of that power.
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