Designing an investment portfolio may be the most important thing you do in investing. There are tips and insights to make you money but over the long haul profitable investing hinges on hedging investment risk as well as picking winners. Here are a few insights into designing an investment portfolio.
Matching Portfolio Risk to the Investor
We have often noted that as an investor ages he or she will commonly want to move to dividend stocks instead of riskier investment. Business Insider gives an example of analyzing the portfolio of a retiree for risk.
What’s one trademark of a poorly designed investment portfolio? The answer is a portfolio whose risk character is incompatible with the risk character of its owner.
Frequently, these risk incompatibilities are camouflaged by a hot stock market. But when the market reverses and begins to fall like it has lately, the problems of investment portfolios with unsuitable risk levels becomes apparent.
Factors to consider are cost, diversification, risk, tax efficiency and long term performance. You may be invested in a fund that pays good returns but those returns are largely eaten up by fees and commissions. If you were invested heavily in big oil you lost heavily when the price of oil fell. Diversification across various market sectors is good. Tax free or tax advantaged investments are good if you are still in your earning years but less important as you retire. Risk and long term performance are closely related. As the author says when the market is hot all stocks look good but when it falls only strong companies hold their value. If you would like to sleep well at night load up on long term strong performers.
Sometimes strategies for designing an investment portfolio do not work out as expected. The New York Times writes about investment strategies mean to lessen volatility and how they may not have worked as expected.
On Wall Street, a cure is proving to be nearly as bad as the disease.
[s]ome experts warn that the sums that have flowed into so-called risk-parity funds and exchange-traded funds, or E.T.F.s, over the last five years have become so large that the end result has been a riskier, more volatile market.
Analysts estimate that there is currently around $4 trillion tied up in these investment strategies. The fear is that as their returns continue to suffer, a wave of investor selling will start a wider market rout as managers struggle to unload high-yield, high-return bonds and equities alike.
Perhaps the most famous investor in the world, Warren Buffett, says that before he invests he must understand how a company makes its money and how it will continue to do so over the years. Buffett generally waits until a household name stock is depressed and buys it. Buffett is the third wealthiest man in the world with assets of about $63.2 billion. When designing an investment portfolio think about what the Oracle of Omaha would do.
Blood in the Streets
Buying solid stocks when the market is down is a time honored strategy for designing an investment portfolio. Market Watch quotes two veteran investors who say that now is the time to buy stocks. The idea being that when everyone is confused about a volatile market there are great deals to be had.
The stock market should be given the benefit of the doubt, according to two investment veterans with at least 50 years of experience each.
I’m referring to Sam Eisenstadt, the former research director at Value Line, and Norman Fosback, the former president of the Institute for Econometric Research and, more recently, editor of Fosback’s Fund Forecaster. Eisenstadt has been rigorously following the stock market for more than seven decades; Fosback has been a student of the market for “only” five decades.
To be sure, Eisenstadt is more bullish than Fosback is. But even he is focusing more on finding bargains than on building up cash.
When designing an investment portfolio be on the looking for strong stocks that are selling on the cheap.