Ok, so now that we know:
- what an investment is;
- that you invest in assets; and
- that people generally talk about 3 kinds of assets (equities, bonds and cash)
we are now at a place where we can start talking about those magical things called Portfolios that everyone talks about 🙂
(If you have no idea what I’m talking about, dear Reader, then please check out the previous post in this series before reading this post! And as always, please check out Financial Vocab 101 if any vocabulary/terminology is unfamiliar or needs refreshing.)
A person’s portfolio is the sum total of all their investments:
It is often talked about in terms of what percentage of the portfolio is in which types of assets (typically: equities, bonds and cash) and represented as a pie graph:
From what I gather about portfolios there are two fundamental things to know:
- Diversification is important.
Basically the more diverse your portfolio is, the lower your risk. The old “don’t put all your eggs in one basket” scenario. This is because if one sector starts going badly (e.g. the stock market) then you have other sectors to pull you through (e.g. bonds). It does seem though that it’s possible to be too diverse… So this non-expert is not interested in trying to achieve the exact right balance of diversification on her own. I plan to leave that up to the experts when I select which specific equity products I buy (I will invest in products that are already diversified) – but more on that in a future post.
- It is completely and UTTERLY up to you and what you are comfortable with 🙂
This is brilliant. Just like The Brat Experiment and anything else you want from life, your portfolio can be molded, adapted and changed to fit exactly you 🙂 How awesome is that, dear Reader? You can structure it to fit your timeline (age?), your risk comfort level, how actively you want to manage it, your personality etc. Check out Investopedia’s Knowing Yourself for more on this.
This means that you can choose exactly what percentage of your portfolio you want to be in which assets. Investopedia explains it really well here. My bestest though is their pie charts at the bottom of this link which (a) show you the ratio of assets for different investing approaches and (b) let you play with different investment amounts in each investment approach. Unfortunately though you can’t look at all the percentages of each pie chart at the same time so I’m going to try and draw it so we can compare them easily 🙂
As I’ve said, which investment approach you go for is ENTIRELY up to you 🙂
BUT I must admit to not loving the names of each investment strategy. This is because I think that they predispose people to think:
“Very Conservative” is good and “Very Aggressive” is bad.
What bugs me is that the names seem to only focus on one type of risk: loss of capital. Which, don’t get me wrong, dear Reader, is HIGH on my list of things to avoid. But it totally ignores even greater (because they are sneakier and more likely to go under the radar) risks: not keeping up with inflation. And the loss of the opportunity to earn compound interest.
(I haven’t explained compound interest yet but in a nutshell: it’s your interest earning interest [in other words your money working so that you don’t have to and earning more money for you than you could ever hope to on your own], all it needs is time [so the earlier you start the better] and it’s AWESOME. The catch-22 seems to be that from my non-expert reading the only asset that really lets you earn interest on interest is equities/stocks/shares – but this is not a problem if you remember that there is a continuum of risk within equities but more on that in a future post… Check out this link for an awesome explanation and demonstration of the power of compound interest).
From my perspective: I’m 29 years old. At our current savings rate we are set to reach financial independence in just over 10 years (IF we use the power of compound interest) when I am in my early 40s. And that means that our money needs to keep up with inflation for FIFTY YEARS after that (three of my four grandparents have lived past 90 years old so I’m being optimistic!). This in turn means that I can’t be having a big percentage of cash that doesn’t grow at all or bonds that struggle to keep up with inflation. I need my money to work for me (so I don’t have to). Put another way: given my timeline, inflation is guaranteed and so my greatest risk is not loss of capital but rather inflation. Therefore, equities are actually the assets that offer me the lowest risk 🙂
So to demonstrate my rebelliousness and disregard for the names of the different portfolio strategies I have chosen colours for the different assets that represent their risk level for me. So for me: cash is red (because it provides no growth and so poses the greatest risk), bonds are blue and equities are green (because they pose the least risk to me) 🙂 But that’s just me. What’s your greatest risk or concern for your investment portfolio?