If you’re new to investing, you’ve no doubt read about the ideal portfolio. Usually a mixture of stocks, bonds, and cash is given as an example. Others may recommend gold, real estate, or non-traditional investments, like wine or fine art.
Stocks are usually added to ramp up the growth of the portfolio. Bonds are often seen as a safer investment and are added as an anchor for turbulent times.
The problem is, there are thousands of variants to the ideal mix.
Is there such a thing as a perfect portfolio?
I don’t think so.
At the start of my investing life, I realised a picture-perfect model portfolio does not exist.
Instead, asset allocation is down to each individual’s desired risk tolerance levels and situation. An extremely cautious person might do best to reduce their exposure in respect to more volatile assets, like stocks and shares, where the risk-to-reward ratio is higher.
Likewise, someone with a longer time frame in the market and who is happy to ride some of the bumps the stock market will inevitably bring might be better off with a higher risk-reward balance. They might reduce their holdings of bonds, where the returns are probably not as high over the long term as shares.
As a long-term investor, I wanted to ensure I was getting the best returns possible in my earlier years, so my investment could compound generously over time. I was unsure of what the best allocation would be for my situation. I surely needed some percentage of bonds in my portfolio to balance it out. But how much?
And then I read JL Collins’s approach to bonds. Collins, the author of The Simple Path to Wealth, considers there are two phases of an investor’s life: asset accumulation and asset preservation. Let’s take a quick look at both, and assess whether this might be a good approach to consider.
Wealth building
Historically, stocks tend to perform better than other asset classes. If you are going to be in the market for a long time, an aggressive portfolio weighed heavily – or completely – towards stocks might be the ideal position.
Wealth preservation
When you are nearing the end of your investing term, and are considering withdrawing some of your savings, Collins believes it is the ideal time to add bonds to your portfolio, in order to add stability. Your wealth has been created, and now is the time to preserve your capital.
Balancing act
Although holding 100% of your portfolio in stocks is an interesting proposition, I question whether many of us could stomach it if the market suddenly dropped by 40% overnight. If we had to sell our position, we would be turning a paper loss into an actual loss. Collins’s take on this possibility is that we should view it as a ‘stocks on sale’ opportunity and buy more.
So, while best asset allocation is different for everyone, I think most investors would be best off holding at least some bonds, or cash. These traditionally safer investments are useful as an anchor against unexpected storms. A portfolio of only stocks is a brave move, and something I wouldn’t be able to stomach.