Today, based on numerous long-term measurements, many or most stock markets appear to be heavily overvalued. Bonds also look expensive by their own long-term standards. Investors need an investment portfolio that is exposed to all likely environments, and committed to none. One which is based on intelligence and reasonable suppositions about the future, and not merely data mining from the past. There is only so much the past can tell you.
In addition to knowing how an investment works, you need to understand what specific role it plays in your portfolio and how it improves your portfolio’s performance. Although there is no predetermined number of investments you should own, once you get beyond five or six, chances are you have got a lot of overlap or you are venturing into more risky investments you don’t need. The fact of the matter is that you don’t need to constantly be adding new asset classes or investments, just because investment firms introduce them or you read favorable reviews. In fact, if you do, you’re more likely to end up with an unwieldy hodgepodge of investments that are difficult to manage, rather than a simpler portfolio that more efficiently balances risk and return.
To get the maximum return while taking the minimum amount of risk, it helps to think of your portfolio as being split into two parts: an equity portion comprised of stocks, and fixed income portion made up of bonds, GICs, and income-generating investments. Generally speaking, the higher the percentage in equities, the greater the risk. That said, there should be a minimum 25% holding of equity-regardless of age. Taking this cautious approach to stocks is less risky than a portfolio invested 100% in fixed-income investments. Moreover, it protects against the negative effects of inflation.
Traditional-minded investors with a love for investing in gold are likely to be shocked by the absence of their favorite precious metal in “the perfect portfolio.” But, fewer investors are prepared to commit any money to an investment that generates no income. Unlike a bond, the metal pays no interest. There is no dividend and it may not protect you against the worst forms of inflation. Moreover, there is no implicit guarantee that it will appreciate in value.
All accomplished chefs know the secret to cooking a great dish is mixing the right ingredients, in the right amounts. Surprisingly, putting together a well-constructed portfolio isn’t much different. As in cooking, you must begin with the correct basic ingredients, in this case stocks, bonds, and alternatives, but if you get the proportions right, the result will be a huge success.