Portfolio construction

When constructing your portfolio, it’s important to remain diversified, but how much attention are you paying to the detailed structure of your portfolio? The process of putting together a grouping of investments that make sense requires more than a little attention, but what should remain is a collection of assets that generate a healthy return whilst limiting your portfolio’s risk exposure.

The most traditional approach to asset allocation for risk-averse investors is a simple 60/40 split between stocks and bonds, decreasing the percentage allocated to equities as an investor gets older. This always seemed overly simplistic to me, as focusing on two asset classes overlooked the opportunities presented by international stocks, real estate, high yield bonds, private placements and P2P lending.

A simple solution is to construct a portfolio with a varied allocation in each of the following 12 asset classes;

1. Growth Stocks
2. Value Stocks
3. Large-cap Stocks,
4. Small-cap Stocks
5. Developed County Stocks
6. Emerging Market Stocks
7. Investment Grade Bonds
8. High Yield Bonds
9. Real Estate
10. Commodities
11. Private Placements
12. P2P Loans

Of course, simply spreading your money across these asset classes isn’t a particularly sophisticated investment strategy. It’s important to carry out rigorous due diligence, especially in more complex investments such as real estate, private placements and P2P loans.

Avoiding assets which you don’t fully understand is key to protecting your capital, but significant gains can be lost by ignoring the range of investment opportunities available in the market.

Although there are numerous combinations of asset classes that are worth considering (and potentially more profitable than simply putting money into a tracker fund), the key point is that with this kind of real diversification it’s quite likely that worthwhile gains will accrue while dampening risk significantly.

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