What Experts Look For In A Strong Investment Portfolio

How To Build A Portfolio That Can Withstand Shocks

Two variables that dominantly underlie investments are risk and return. Investments are driven by the quest for returns: an investor expects to earn a good return on his investment. Unfortunately, the same process of seeking returns can indeed see your investment vanish, leaving you without returns and without your capital.

The Risk Factor
There is a risk associated with any investment. Investment deals with the future. Even with a crystal ball, nobody has ever been able to foresee all the future occurrences that can affect the economy, the markets, industries and the investments. If anybody did, he would have cleaned out the world and had the rest of us working for him. Truth is, careful hard-driving analysts can achieve a measure of success in reading the economy and predicting the markets, but no one can ever get it perfectly right. Most people will get it wrong many of the times. This is where investment becomes a game of high risk. There is systemic risk which refers to the risk inherent in the market - possibility of recession, spiraling inflation, unexpected interest rate movements, a massive slide in a bear market, etc. There is also unsystemic risk relating to peculiar risks of the industry or company. The bottom line is that the investor must recognise and understand these risks and take proactive steps to protect his investments.

Portfolio Approach To Risk Diversification
One way to protect your investment is to build a portfolio of investments which inherently protects itself from the vagaries of systemic and unsystemic risk. A portfolio of investments simply refers to a 'bag' or assortment of investments. It becomes a diversified portfolio when it is a collection of carefully selected investments of different classes and characteristics such that the overall risk profile of the portfolio is minimised (diversified out). This means that the likelihood of a huge loss of value is reduced to the barest minimum. This is achieved through an informed asset allocation process, guided by the risk correlation of various assets. Correlation, a statistical attribute, indicates how closely two investments will be affected the same way by market forces. If two assets are driven in the same direction, they are positively correlated. Correlation could be positive, negative or random. When investing, these factors must be at the back of your mind as a poor collection of assets could suddenly suffer a massive loss of value because they are similarly affected by the same variable. Your aim is to diversify out risk by minimising positive correlation within your portfolio.

How To Build Your Portfolio
You build your portfolio by an asset allocation process. In asset allocation, you decide how much of your investment to place in various classes of investment: stocks, bonds, savings accounts, certificate of deposits, real estate, etc. The goal is not to "put all your eggs in one basket". Sounds easy, but it isn't necessarily so. The reason is that your objective is not just to allocate assets to avoid risk. Your primary goal is to invest for good returns. The process of risk diversification will likely affect that objective - the risk/return trade-off: to reduce risk you may lose some potential for profit. If you've come to terms with this fact, then go ahead and resolve the following steps:

1. Setting Your Investment Time-frame: If your are speculating over a short term, you would possibly take a lot more risk that if you are digging in for the long haul. In the former case, you are possibly watching more closely and are ready to bail out real fast. If, on the other hand, you are saving for retirement, low risk will mean more to you.

2. Clarifying Your Investment Goals and Risk Tolerance: A goal to simply maximise returns will logically put you on potentially high-yield, albeit more risky investments. If what matters more is the safety of your investment, the weight tilts towards highly safe instruments like Treasury bills and Government bonds.

3. Choosing Asset Classes To Log Into: You have to get down to choosing asset classes to invest in. This process should see you spelling out what proportion of your investment to hold in each category (stocks, bonds, savings accounts, certificate of deposits, real estate, etc), dictated by your horison and goals. In effect, the general mix of asset categories should be set out. The idea is to see that you don't just arrive at a portfolio mix by default but through a careful selection process informed by expectation of returns and a risk trade-off. Low or negative correlation should rank high in the selection process.

4. Selecting Specific Assets To Invest In: Eventually you'll have to invest in specific assets whose selection may need a lot of further classification. If you've chosen, for instance, to invest 45% of your portfolio in stocks, various levels of further analysis will be necessary. What sectors? Banking, Food and Beverages, Petroleum Marketing or what? When you have settled for specific sectors, each sector still has various stocks that can be further classified: are you for low-priced or high-priced stocks?; are you investing for value or based on market sentiment; are you more interested in dividend payouts or capital appreciation? What all this means is that you need to understand the specific stocks and make choices that fit into your overall objectives. This same process should apply to other classes of asset that you have chosen to include in your portfolio. In the end, you are aiming to build a portfolio that should deliver the kind of returns you desire and present the kind of risk which matches its profile.

Would You Need Help For This?
This much depends on your background and what you know about investments. A do-it-yourself approach, which is generally our style, will not always pay good dividend. Things are changing in the society and part of what people should learn is to use professionals and experts in certain important processes. Most times, the cost is more that compensated for by the value delivered to you. If you can package your investment portfolio, by all means do so. If, however, you doubt you can, do well to get help. The benefit will justify it.

Rebalancing Your Portfolio
Things change all the time and your portfolio will not be a cure for all seasons, if it is not tweaked from time to time. The process of rebalancing entails reviewing the portfolio to see that it still meets your investment objective, either as earlier set or as now modified. Rebalancing may require new investment of funds or sale and realignment of some existing investments (tax charges should be considered). Whichever, the objective is to see that your portfolio is optimised, based on current market conditions.

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