Where does one put their money? It’s the million dollar question isn’t it?
If only we had a crystal ball and could predict which stocks were going to get us rich!
Let me break it to you now. No one can predict what stocks are going to do and where the markets are headed. Like those who study the fundamentals, I make calls based on the headwinds and tailwinds I see – but I don’t know when the market trajectory will change.
However, I don’t really worry about it. Because I know that creating a well-diversified portfolio in line with my money personality and goals is the BEST safeguard for my money. And frankly I don’t have time or the inclination to trade in and out of the market!
In this article, I’m going to talk about the key factors you need to think about to build a well-diversified portfolio so you can invest in the markets and not lose sleep!
What is an Asset Allocation Model?
This is where you divide your pool of money among different types of assets such as stocks, bonds, cash etc. in line with your goals, time horizon and risk tolerance.
Why is it Important?
Diversification! Diversifying your assets helps you manage risk. You need to earn a decent return on your investments if you want your wealth to grow, but you don’t necessarily want to take a big risk to do it.
Not all assets react to the markets and economic cycle the same way and so they will perform differently at any given time. Building a portfolio with assets that are unrelated (or uncorrelated) to each other will help you better endure the unpredictable nature of the markets. Read more about diversification here.
Furthermore, one country or region’s economy will be different from another, which is also why one needs to consider holding investments outside their own country.
Alignment to Goals & Personality. How you diversify your pool of money needs to take into your account your life plans. Will you be making a big purchase such as a car or house soon? When do you plan on retiring? How much regular income do you need to generate from your investments? Do you lose sleep easily when you lose money or can you tolerate some risk?
Building Your Portfolio
Since each asset class has different levels of risk, returns and liquidity, as an investor you need to consider your investment objectives, your comfort with volatility, when you’ll need the capital and how much. There are many different types of asset allocation models but they generally fall into three buckets.
The above are guidelines. How much and the types of stocks, bonds and cash you hold will depend on your particular situation.
Once you’ve created your portfolio investment strategy, remember to review your portfolio at least annually to see if the weightings and performance still work for you. For example, your stocks portion may perform very well and tilt the weightings to say 50% to 60% which in turn will change the risk profile. You may want to consider rebalancing your portfolio by selling some of your stocks. Your circumstance may also suddenly change and this will warrant a review.