10 tips for building your investment portfolio

Building portfolio

Warren Buffett once said, ‘Investing is simple – but not easy.’  Here are ten simple tips to make investing that little bit easier – whoever you are.

In investing there are no absolute right or wrong answers, only better or worse solutions.  Better solutions are founded in a process that encompasses insight into the problem (‘How should I invest?’), are focused on reducing uncertainty (with as little risk as possible) and which have a solid and consistent decision-making process (‘Should I go right or left here?’). In the words of Albert Einstein, ‘Make it as simple as possible, but no simpler.’

By following these guidelines, you give yourself a far greater chance of constructing a portfolio that works for you – no matter what is going on in the markets. You can also avoid the common pitfall of making decisions with the heart rather than the head.

  1. Start with your goals in mind

Remember, a portfolio is not a plan.  What is it that you want to achieve from your portfolio?  Start with your key life goals, looking at the ‘what’, the ‘how much’ and the ‘why’. For example, ‘To be able to stop work by age sixty’ (the ‘what’), ‘while still supporting a lifestyle costing £50,000 a year’ (the ‘how much’), ‘so I can travel the world’ (the ‘why’).

  1. Balance is everything

Capitalism works, so let it do the heavy lifting as you try to generate returns from your portfolio as either owner (equities) or lender (bonds). Finding the right balance between the two is key because, of all the influencing factors, it is balance that has the greatest impact on both risk and return.

  1. Know your risk profile

If you want to achieve that ideal balance in your portfolio, you need to understand your risk profile. There are three components that define how much investment risk you need to take: the first is how much risk you can tolerate (this is a psychological trait), the second is your financial capacity for losses (a function of your wealth and future lifestyle needs), and the third is the financial risk that you need to take in order to achieve the necessary returns to achieve your goals. Aligning these three components is one of the most important processes you will go through if you are to have a successful investment experience. Only once you understand this can a sensible and suitable investment portfolio be structured.

  1. Don’t put all your eggs in one basket

See point 3 above. A lack of diversification is an inherently high-risk strategy and almost certainly will not match your risk profile.

  1. Investing is a ‘get rich slow’ process

Any investment ‘opportunity’ which appears to promise stellar returns should be treated with extreme caution. And then rejected.

  1. There are no low risk, high return investments

See 5 above. If it looks too good to be true, it is false.

  1. Price volatility is not the same as risk

A very important point to understand. Liquid investments fluctuate in value based on supply and demand. In general terms, stock markets are falling one third of the time, recovering one third of the time and breaking new heights for the remainder. What matters to you is overall performance over the period of investment, based on your carefully designed strategy. Don’t turn a temporary fall in value into a permanent loss of capital by baling out when things look bad.

  1. Capturing the market return is a valid objective

Imagine a hypothetical market that has only two investors. The first owns all the stocks that beat the market – so, by definition, the other investor must own all the ones which underperform it. The aggregate of their two portfolios is the market return, before costs. In other words, stock markets generally are a ‘zero-sum game’.

There is a mountain of academic evidence to show that few professionals ‘win’ over the sorts of time frames in which most investors are interested. Furthermore, winning funds are virtually impossible to identify in advance. Therefore it makes sense to use ‘passive’ funds that seek to deliver the return of the markets, rather than to beat them.

  1. Investment costs matter

‘In investing, you get what you don’t pay for.’ – John Bogle, founder of Vanguard.

Do your homework and make sure you know the total cost of anything in which you are planning to invest. High returns can be eaten away by high fees, but the latter are easy to miss.

  1. Manage yourself as tightly as your investments

A tried-and-tested way to destroy your wealth unnecessarily is to make hasty investment decisions based on emotion or gut instinct. Be dispassionate and rational about your investment decisions, stick to your plan, and when in doubt consult again with your financial adviser.

 


The above article was first published by unbiased on the 16th January 2017