The right way to have a diversified portfolio

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To start, what is a diversified portfolio? You can consider that a portfolio is diversified when it reaches the point where the portions dedicated to stocks and bonds are spread enough to meet someone’s risk tolerance and gives him the highest to return for it.

There are different approaches in splitting your money between stocks and bonds.

The most popular one is the age-based approach. The rule goes like this, you take 100 minus your age and it gives you the percentage you should be investing in stocks.

Take me as an example:

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I’m 29 years old, so 100-29 = 71, meaning that I would be investing 71% in stocks and 35% in bonds.

The thinking behind it is that of time diversification. It is known that time diversifies risk. Consequently, in the long run, the return/risk trade-off for equities improves over that of all other asset classes.

Which would mean that younger investors can invest more in stocks than older investors because they have more time ahead of them.

However, we all go into different stages in life which each carries different goals. Therefore, the one I advocate most can be compared to a life-cycle fund. A life-cycle fund is related to retirement. Indecently, the asset-allocation of this fund will be adjusting itself by putting more weight in bonds as you get closer to your retirement.

But what about the other goals you have?

Having a well-diversified portfolio based on objectives

In my opinion objectives can be spread into three terms:

Short term: Objectives that are a year from now

Medium term: Objectives from a 1 year to 5 years

Long term: All your objectives beyond 5 years

Here, is a table to give you an examples

TermsShort (0-1)Medium(1-5 years)Long(5 years +)
ObjectivesAt this stage you will be getting ready to withdraw your money-Savings to a down payment for a house
-Savings for a big trip
-Savings to renew your furniture
-Savings to buy a new car
-Savings for your child education
-Savings to buy a second property
-Retirement

Asset allocation: what it does for your portfolio

In the same line, I have an asset allocation for each stage:

Short term: You should favor 100% of your stack on money market funds or any other asset they can guaranty your capital from decreasing and that ideally have a growth equal to that of the inflation

Medium term: Here is suggest a 60% in stocks and 40% in bonds. This, particularity, all clients at the bank have.

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Long term: In this stage, I suggest having 80% in stocks and 20% in bonds. In that case, you have many years ahead, you can handle the high volatility caused by your stocks portion.

In addition, having some portion in bonds will give you the opportunity to have money easily on hand to buy stocks on a discount when we will hit a recession or like let’s say a pandemic!

Benjamin Graham’s approach on a diversified portfolio:

As stated in his book The Intelligent Investor:

“We have suggested as a fundamental guiding rule that the investor should never have less than 25 percent or more than 75 percent of his funds in common stocks, with a consequent inverse of between 75 percent and 25 percent in bonds. There is an implication here that the standard division should be an equal one or 50-50, between two major investment mediums. Furthermore, a truly conservative investor will be satisfied with the gains shown on half his portfolio in a rising market, while in a severe decline he may derive much solace from reflecting how much better off he is than many of his more venturesome friends.“

Lastly. whatever allocation you finally decide, I think with this post you will have the judgement needed to take a good decision.

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