A recent client visit and January’s market drop reinforced a fundamental tenet of how I believe money should be invested. An investment portfolio should be fully diversified. It should contain a mix of equities and fixed income that balances growth with preservation, and levels out the peaks and valleys that accompany volatility. This conviction has sometimes been difficult to support when it typically results in a lower rate of return relative to broad market growth seen in recent years.
Experience has taught me that the angst of missing some equity market growth is mild compared to the pain of seeing a portfolio go down in lock step with declining equity markets. While it is unreasonable to expect investment strategies to be shifted significantly in anticipation of market swings, it is very reasonable to expect to have a basket of different investments that smooth out volatility. Only by having a mix of stocks and bonds can the investor trust a portfolio to ride market swings and not get derailed before achieving the desired results.
There are many ways a portfolio can be diversified. The first step is to complete a self-assessment of how much risk you are willing to take or how much of your portfolio you are willing to lose. Since the former is less tangible and sometimes influenced by what markets happen to be doing at the time, the latter may be a more effective way to make an assessment. Once done, structure the portfolio with a mix of equities and fixed income that closely mirror your tolerances.
Keep in mind when selecting investments that it isn’t wise to rely on one or two different types of equities or fixed income. Equity selection should include U.S. and international based companies. Companies are measured by market capitalization (large, mid and small-cap) and whether they are growth or value oriented. Portfolios should contain selections representative of all these subcategories. Our preference is to give heavier weightings to Exchange Traded Funds (ETFs), mutual funds and individual stocks that are large-cap and value oriented because they tend to carry the least amount of risk. Smaller weightings are given to mid and small-cap investments because of increased risk.
Fixed income is similarly complex. Like equities, consideration should be given to bonds issued by U.S. and internationally based companies. When a bond matures is a factor, as is whether the income produced is taxable or tax-exempt. Another ingredient is the right mix of government backed bonds, like U.S. Treasuries, and the traditional corporate bond, which is backed by the strength of the issuing company. Both have their pros and cons and should be reflected on when building the fixed income portion of a portfolio.
Getting the mix right is a challenge but resources are available to help. While it isn’t a perfect science, with some work upfront, steps can be taken to build a solid portfolio that endures market swings and achieves long term goals. Click here if you are interested in learning more.