Last week we looked at the relationship between risk and return, and how that impacts the asset classes you might invest in. This week we continue with our step-by-step guide to constructing your portfolio.
Step 4: Which asset class will you invest in?
Once you have decided how much risk you are prepared to take, you can put together a suitable combination of growth and defensive assets to suit your risk profile. Let’s say I am a balanced investor, there are a number of different ways to construct an investment portfolio of 30% defensive and 70% growth assets:
30% cash and 70% shares
10% cash, 20% bonds, 70% shares
15% cash, 15% bonds, 50% shares, 20% property
Which asset mix you choose will depend on your time horizon, how comfortable you are investing in each asset type and how much money you have to invest. For example, investing in residential property requires a large amount of money upfront, making it unavailable to many investors.
Step 5: Which investments will you make?
Once you have decided which assets to invest in, the next decision is how to access each investment. Will you put your cash into a high interest savings account, or a term deposit? Will you invest in equities via a managed fund, or will you invest via an exchange traded fund?
If you are unsure, it is worth going back over the previous blog posts dedicated to each asset class to decide how you want to access your investments
Step 6: How will you monitor the investments?
Once you have made your investments, you will need to monitor them to ensure they are performing in line with your expectations. You should review the performance of your investments at least semi-annually.
Keep in mind that investment performance can be very volatile, don’t be too hasty to sell your investments. Only consider selling if something fundamental has changed in your investment strategy, or your goals, which makes the investment split inappropriate.
Step 7: How often will you rebalance your portfolio?
Portfolio rebalancing refers to bringing your portfolio back to its initial asset allocation. For example:
You decide to invest your $10,000 portfolio in 30% bonds, and 70% equity
1 year later, the share market has risen 20%, and the bond market has risen 5%
At the end of year 1 you now have $8,400 in shares and $3,150 in bonds. This means that your portfolio is now invested 73% in shares and 27% in bonds.
To rebalance your portfolio, you need to sell the extra 3% in shares and reinvest them in bonds.
We recommend portfolio rebalancing at least annually. Research has shown that portfolio rebalancing increases returns, and decreases risk, making it a worthwhile exercise.
There is a lot of information in the above post, next week we go through some worked examples to help put the theory into action.
The information in this blog is of a general nature only and may contain advice that is not based on your personal objectives, financial situation or needs. Accordingly you should consider how appropriate the advice (if any) is to those objectives, financial situation and needs before acting on the advice.