Step 4: Build a balanced portfolio
Your investment portfolio will consist of all of your individual investments in stocks, bonds, portfolio funds, Unit Trusts and other instruments.
The goal of any portfolio, whether you’re just starting out or have decades of investing experience, is diversity.
The idea is to invest in enough different sectors of the economy so that if one investment does poorly, your other investments will make up the difference.
If you have too many of your eggs in one basket, you could end up magnifying your risk.
A diversified portfolio spreads the risk evenly so that no single mistake will ruin everything.
As we mentioned in step 3, the best investment strategy for new investors with limited funds, is to invest in portfolio funds using Rand-cost averaging.
This allows for regularly scheduled, modest contributions.
The great thing about portfolio funds is that they come in all flavours, meaning it’s relatively easy to pick and choose a handful of portfolio funds to create a diversified portfolio.
Typically, a diversified portfolio should include investments in five major areas
- Local stocks/equities (both large and small companies)
- Foreign stocks
- Bonds and Income Funds
- Commodities (tangible goods like petroleum, energy, precious metals and agriculture)
An easy way to invest in these different sectors is by investing in index funds. Index funds are portfolio funds that are diversified across a particular sector.
An example of the above would be a portfolio fund like the STANLIB ALSI 40.
This portfolio invests in the Top 40 companies listed on the local JSE and the portfolio manager closely tracks the performance of these Top 40 shares.
There are also more conservative options for the more conservative investor, such as Bond funds and Income funds that invest in a diverse mix of local and foreign government bonds and corporate bonds.
There are also Property funds that one can consider, that invests in both the residential and commercial property sectors.
By investing in these types of funds (portfolios), not only do you achieve basic diversity across the five major sectors, but the investments within those five funds are also highly diversified. That’s called “covering your bases”.
Now that you’ve built a diversified portfolio, you need to balance it. Even with diversified portfolio funds, some investments are riskier than others.
You need to carefully consider the ratios needed to achieve that balance and spread your risk as evenly as possible so that you can achieve the goals you set yourself.
If you’re not sure how to go about doing this then consult a qualified financial adviser to help you.
For young investors, most of your money will go into stock/equity portfolio funds, perhaps 35 percent in local stocks and 25 percent in foreign stocks.
The rest will be split among bonds, property and commodities; perhaps 15 percent each in bonds and property and another 10 percent in commodities.
The trick is maintaining this balance even as some sectors perform better or worse than others. With Rand-cost averaging, this is actually pretty easy.
Let’s say that last month your stock/equity fund performed poorly, but bonds did great. This will temporarily throw off the balance of your portfolio, because bonds will suddenly represent more than 15 percent of the total value of your investments.
Instead of selling off some of your bond investments to bring the ratio back to normal, you need to pump more money into stocks/equities.
At first, it sounds strange to invest more in the worst-performing sector of your portfolio, but based on the principles of RCA, you get more shares for your money and keep the average cost of the investment down over the long-term.