How to build a portfolio that has enough of everything in it

1. How a good investment portfolio differs from a bad one and whether you should look for the perfect portfolio.
2. According to what principles it is reasonable to build an investment portfolio in order to earn and not lose money.
3. How to manage an investment portfolio.

An investment portfolio is all the assets you have invested in. In a broad sense, assets are not just stocks and ETFs. They include bank deposits, a stake in a startup, and income-producing real estate. For example, think of your bank deposits as investments because deposits have a term and usually generate a fixed income. So if you have a lot of deposits, it might make sense to focus more on stocks.

Portfolio formation is all about finding the optimal mix of assets for yourself. We have already studied stocks and funds. But, as you already know, ETFs are portfolios of securities and assets selected on the same principle. Accordingly, if you buy a share of an ETF on U.S. technology stocks, you are actually investing in stocks. If you buy a stock ETF on bonds, you are investing in bonds.

So when putting together a portfolio, the main ratio you should decide on is how much should be in bonds and how much should be in stocks. How many different ETFs should be in the portfolio and how many should be in stocks.

This whole process is characterized by one word - "diversification". It is the allocation of money between different assets in such a way that you are satisfied with the return and risk.

Objective

Determine why you are investing. For example, you want to save for an apartment, or to receive a stable passive income from the amount you have already accumulated, or to save for education. The more specific you define your goal, the better: it is important to understand how much money you need, for what purpose, and in what currency.

Investment Horizon. This is the term for which you are investing your money. For example, you want to buy an apartment in seven years. The investment horizon is seven years - that is how long you will need all the money you have invested.

The more time you have, the more of your portfolio can be invested in stocks. If the stock goes down a lot, you will have time to wait for prices to recover.

If you are still having trouble identifying a specific goal, but you already want to start investing, you can calculate a stake in stocks based on your age.

"100 minus age = % of stock."

According to this principle, 35-year-olds can invest up to 65% of their funds in stocks, while 65-year-old investors will allocate this share to bond ETFs. The logic is simple: the younger the investor, the longer his investment horizon and the more opportunities he has to make up for lost time. Consequently, a young investor can invest most of his savings in riskier assets - stocks. Statistical studies show that over the long-term horizon, stock returns always outpace bond returns.

However, over time, the investment horizon shrinks - it's worth gradually reducing the share of stocks and moving money into stable ETFs.

Risk attitude. Another thing to consider is how much risk you are willing and ready to take for the sake of potentially high returns. The more tolerant you are of price fluctuations and the risk of losing money, the larger the share of stocks in your investment portfolio can be.

The guidelines here are roughly as follows.

Afraid of risk

If you are not ready to see your portfolio value drop by more than 10-15%, you are a conservative investor. On the stock exchange, you are better off choosing reliable ETFs.

I can take a little risk

If it is acceptable for you to temporarily drop the value of your portfolio by 20% or a little more, you can invest with moderate risk. The share of stocks in such a case can reach 30-40% when investing for a few years and up to 60% when investing for decades.

Management companies and investment funds most often create portfolios with moderate risk. That is, they invest 60% of their funds in stocks and the remaining 40% in bonds. As we have already mentioned in the lesson about stocks, this ratio roughly coincides with the proportions of liquid stocks and bonds on the global financial market.

I am not afraid of risk

If you are sure that you can withstand a serious decrease in the value of your portfolio in a crisis, for example by 50%, you can invest up to 90% of your portfolio in shares. The main thing is not to overestimate your resilience: thinking about the crisis and feeling it is not the same thing.

If you don't take into account the investment horizon and attitude to risk, you can get into an unpleasant situation. For example, an investor does not like to take risks and is afraid that his portfolio will fall in value, but he invested all his money - 10,000 dollars - in American stocks in the hope of higher returns. The crisis began and stocks halved in price. Now his portfolio is worth not ten thousand, but five.

If an investor was really prepared for risk, he would not be embarrassed by the fall. Perhaps, he would have even replenished his account and bought more shares while there was such a sell-off. But the investor got scared and sold all the securities for 5,000. So he lost half of his capital - all because he overestimated his willingness to take risks.

Let's say you have thought it over and decided that you are ready to invest for 10 years to accumulate a large sum of money. Your risk appetite is medium, i.e. a moderate risk is acceptable. In this case, the optimal portfolio is 60% in stocks and 40% in bonds in the form of ETFs.

You've decided on your asset shares - now it's time to diversify them. And the more, the better.

Imagine a certain investor decides to put 60% of his money in stocks and 40% in ETFs. So far, everything looks good. But in reality, he only bought Apple stock and the iShares TIPS ETF.

The iShares Expanded Tech-Software Sector ETF tracks the investment results of an index consisting of North American stocks in the software industry and select North American stocks from the interactive home entertainment, interactive media and services industries.

Such a portfolio is dangerous: it depends on the state of only one sector of the economy - IT. If there are problems in the sector, this portfolio will suffer greatly.

Putting all your money into just one industry or company is risky.

Let's look back at the Japanese financial bubble. In the 1980s, stocks were booming. Due to the strengthening of the yen, Japanese companies imported technology and invested in production more cheaply. Their competitiveness grew, and with it their profits. The Bank of Japan began to liberalize the market: loosened control over interest rates, gave market access to foreign banks and investment companies, expanded operations with derivative financial instruments. All this led to the fact that Japanese banks received a large inflow of foreign capital, but began to use it not for loans to the productive sector, but for speculation in real estate and stocks. As a result, on December 29, 1989, Japan's main stock index Nikkei 225 reached its all-time high and... 9 months later it was already down by half.

Those who invested then only in Japanese stocks lost a lot of money.

More prudent investors invested in stocks of different countries - Japan, the US, European countries - and were on the plus side, because other markets were growing at the same time. It's the same with industries: if you put all your money in oil companies in different countries, it won't really increase diversification.
Let's understand how to diversify properly and how it can be done by industry and country.

By industry

There are two tips for this. First, look at the market capitalization of the industry - that is, what share it occupies in the global economy. And allocate the same share in the portfolio to it. To avoid calculating this yourself, just look at the portfolio composition of one of the world indices. For example, Morningstar Gbl Allocation TR USD index from Morningstar analytical company is one of them. You can use it as an example to build your own portfolio.

The composition of the index can be viewed here.

Second, we need to consider the phase of the economic cycle.

On the eve of a crisis or recession, invest more in protective industries such as health care, basic necessities and electricity. There is always a demand for medicine, food and electricity, which means that even in a crisis, companies in these sectors will continue to make money.

When the economy, on the contrary, starts to develop and grow, it is worth investing more in industry, technology and raw materials.

By country

The same principle should be followed here as in the distribution by industry - invest in proportion to the country's share in the global economy. The Morningstar index can be a reference point. To do this, go to the Portfolio tab, find the Exposure section and select the Region breakdown.

Not only shares of American companies are traded on the US market. In the Vita Markets catalog you can find, for example, shares of the Chinese Alibaba and the iShares MSCI China ETF iShares MSCI China ETF

The iShares MSCI China ETF is an exchange traded investment fund that seeks to track the performance of the MSCI China Index. This index consists of Chinese stocks that are available to international investors.

An investment portfolio sometimes needs attention. For example, rebalancing - restoring the original asset mix - may be necessary a couple of times a year.

Let's look at a moderate 60:40 portfolio. Over time, stocks could appreciate a lot and the asset ratio could become 75:25. Conversely, if stocks get cheaper and ETFs get more expensive, the equity ratio will fall below the required 60%.

Asset proportions change → Portfolio risk level also changes

If stocks take up too much of the portfolio, the portfolio will become too risky: in a crisis, its value will fall dramatically. If the share of equities drops significantly relative to the initial share, the portfolio will become overly conservative and will generate less than desired returns.

In such a situation, the original proportions of stocks and bonds should be restored. The proportions of all instruments within each asset type should also be restored. For example, if you bought Microsoft shares for 5% of your portfolio, and then they went up in price and took up 10%, you should restore the original 5%.

Rebalancing a portfolio can be done in many different ways:

• Replenish the portfolio and buy more of those assets that have fallen in price.
• Use all coupons and dividends to buy cheaper assets.
• Sell some of the securities that have gone up in price and buy the assets that have gone down in price with the money received.

It makes sense to rebalance if the asset ratio has deviated significantly from the target, for example, by a quarter or more. If the share of the asset as a whole or of an individual instrument has deviated by 1-2% from the required one, you can do nothing: the portfolio characteristics have not changed much.

As you get closer to your goal, you should reduce the share of stocks and increase the share of bond ETFs and deposits. In our example, the investor wants to accumulate a large sum in 10 years and is willing to take a moderate risk. So, for the first few years, it is perfectly acceptable to keep 60% of the funds in stocks and 40% in bond ETFs.

Then you should gradually reduce the share of equities. In 2-3 years before the target, the share of bond ETFs should increase to about 60% of the portfolio. When there is less than a year left in the stock market, it is better to move 80% of the portfolio to reliable ETFs.