Whenever you are dressing up for an occasion, you want to make sure each and every piece of clothing you are wearing, spices up your look. Whether it’s the tie, socks, or any jewelry. That’s where fashion designers make money from. They know how to mix colors, patterns, and ornaments for you to look amazing.
On the other hand, chefs are able to cook delicious meals by mixing different ingredients and making finger licking good delicacies.
Similarly, as an investor, if you want the best out of your investments, you must craft your portfolio paying attention to some critical factors.
In this article, we discuss some of those factors and also other considerations that you should make when building your portfolio.
Factors To Consider When Building Your Portfolio
Young people, who are just getting started with their careers, can take up more risk in their portfolio than older people who are approaching retirement. This is because they have a lot of earning years ahead of them. They can hence recover any losses before they approach retirement.
On the contrary, people who are approaching retirement should be very conservative in their portfolio. They have very few years remaining to make more money from their jobs. Hence if they lost a big chunk of their investments, they would have no source of income in their retirement. They would then be forced to depend on their families or well wishers for them to meet their daily needs in retirement.
There are two kinds of investors; risk averse and risk tolerant. Risk averse describes the investor who chooses the preservation of capital over the potential for higher- than – average return. Being risk averse implies that you invest in asset classes where you have very little chance of losing your money.
On the other hand, Risk tolerance implies that your financial situation can tolerate risks even though you don’t necessarily go seeking it. This means that you are comfortable losing your capital in pursuit of higher gains.
It is important to know and understand the kind of investor you are based on your risk appetite. You can do a quick test online to determine if you are an aggressive, moderate or conservative investor.
“Unless you can watch your stock holdings decline by 50% without becoming panic – stricken, you should not be in the stock market.”
Oftentimes, people try to mirror the portfolios of other famous investors, friends, work colleagues or even family members. What they fail to understand is that people have different financial goals. Hence one should adjust their portfolio based on their own financial goals, not based on what others have on their portfolios.
Features of A Good Portfolio
They say that diversification is the only free lunch in investing and for a good reason.
The only way you can preserve your wealth is by diversifying into different asset classes. So that in case one asset crashes or isn’t doing well, you can counterbalance those losses with other assets in your portfolio. The importance of diversification cannot be overemphasized.
As Jason Zweig writes,
“Whenever people start questioning the value of diversification-overconcentration and overconfidence must be on the rise, and the risk of being under diversified is likely to materialize.”
Remember diversification doesn’t depend on how many investments you have. It depends on how different your investments are from each other.
Liquidity is how quickly you can convert an asset into cash. A good portfolio should be both solid and liquid. That means that it should have assets that can easily be converted into cash when the need arises. These assets are like Money Market Funds.
If your portfolio only has parcels of land and property, you may face liquidity issues in the future, since it’s not that easy to sell a parcel of land or a piece of property.
And as Jason Zweig famously wrote in the Little Book of Safe Money,
“No matter how valuable an investment may be, it is of no practical value to you unless it’s liquid when you need to cash out. Just as travelers die in the wilderness without water, investors perish if they have no liquidity.”
Cash is King
One of the things that people struggle dealing with in their portfolios is the cash proportion. Cash is basically the money that you have in your bank account, either to meet your daily expenses, or to bounce on investment opportunities that you anticipate to occur in the near future.
Cash is the most basic building block of a portfolio. This is because, if you ever run out of cash, your assets are in danger of being sold so that you can meet your cash demands.
That’s why cash flow is important. You don’t want to be wealthy, yet you can’t pay your rent since all your wealth is in solid assets. You have no cash with you.
An investment portfolio is like a class of students. No matter how hard you try to rebalance, if your class is well diversified, some students(investments) will always perform better than others. The right portfolio is the one you can stick with to help you achieve your goals.