WWhat constitutes a diversified portfolio? The general answer, according to conventional wisdom in the investment industry, is that diversified portfolios contain enough different stocks to avoid the risk of problems in one area of the market, or that one stock takes you away from your goals. investment.
But in the many years since financial commentary on a global scale, we’ve seen that it can mean different things to different people. One claim that Fisher Investments UK comes across often from the financial commentators we follow is that a truly diverse portfolio mixes stocks, fixed interest, gold, other commodities, cash, real estate. and maybe cryptocurrency, so that if one asset class stumbles, others might pick up. slack or cushion the damage. In our opinion, this is a fundamental error: to confuse diversification and asset allocation.
Asset allocation is the combination of stocks, fixed interests and other securities in a portfolio. In Fisher Investments UK’s view, any investor’s asset allocation should be based on their long-term goals, time horizon (the time their money needs to meet those goals), cash flow needs, risk tolerance and other personal considerations.
Although different people have different needs, of course, in general, it is wise to make lasting changes in asset allocation only when one of these factors changes to the point that the achievement of long-term goals. requires a different combination of expected risk and return.
For example, a young investor who is decades away from retirement, who seeks long-term growth, who does not make regular withdrawals, and who does not plan to withdraw funds in the short term is probably better off with a fairly heavy allocation to equities, provided that this matches their risk tolerance. With this time horizon, they have time to reap long-term market returns even if they experience bear markets along the way, and they don’t have to worry about making withdrawals after a downturn. ¹ (A bear market is a deep and long decline of 20% or worse with an identifiable root cause.)
Meanwhile, someone well into retirement and making regular withdrawals might benefit from a mix of equities and fixed interests – again depending on their risk tolerance and other investment goals. While historical returns indicate that this allocation would likely sacrifice some long-term return, it would likely also reduce short-term volatility and reduce the risk of making withdrawals after a sharp drop. ² Someone who plans to use all his savings to fund a down payment on a house in the next year or two might be better off in cash or cash-like securities, in our opinion, lest a drop in stocks or fixed interest put their short-term goal out of reach.
Commentators who argue that diversified portfolios should include a wider range of assets would likely judge these three investors to be insufficiently diversified, taking excessive risk. They might ask, where is the gold and commodities to hedge against inflation? Real estate? Cryptocurrencies?
Fisher Investments UK sees this as a problem and a mistake. In our opinion, the problem is that mixing all these disparate assets, just for perceived diversification, could result in an asset allocation that is not in line with your personal circumstances. The mistake, in our opinion, is that these categories are exposed to both risks and opportunities that you cannot get with stocks and fixed interest.
To see how it works, we think it’s helpful to consider commodities. Research from Fisher Investments UK shows that gold and other commodities are not a reliable hedge against inflation, contrary to claims we have seen from several financial commentators that we follow. Yes, general economic theory holds that commodity prices should rise with inflation in the very long run, but our research shows that they can fall and fall when inflation rates are above average.
But that aside, investors can easily gain exposure to the commodities market through equities, thanks to the energy and materials sectors. Profits of oil companies tend to rise and fall with oil prices, according to our research. Metals and mining companies, which are part of the materials sector, are also sensitive to copper, nickel, iron ore and other metals in general, according to our findings. We have also found that stocks of gold mining companies tend to benefit when gold prices are high. By seeking exposure through stocks, rather than commodity futures or physical ownership of precious and industrial metals, an investor technically holds a stake in the profits generated by those commodities. You can research the companies that are best placed to capitalize.
Fisher Investments UK believes a similar logic applies to all other asset classes that are considered necessary in a diversified portfolio. Real estate? Well, listed real estate investment trusts (REITs) are included in general stock market indices such as the MSCI World Index. REITs trade like stocks and are essentially stocks, providing easy and liquid exposure. (Our views do not apply to unlisted or non-traded REITs, which we believe pose many problems.)
Meanwhile, we think cryptocurrencies are a trendy and crowded bandwagon. But if you don’t agree and want to be exposed, there are a number of Bitcoin-related startups that Fisher Investments research has found to be primarily in line with cryptocurrency prices. Owning shares of related companies, rather than the cryptocurrencies themselves, circumvents the drawbacks of direct ownership (e.g. the relative lack of security on some cryptocurrency exchanges, the lack of recourse in case theft, potentially complex taxation, etc.).
In the view of Fisher Investments UK, truly diversified portfolios are those that diversify within their prescribed asset classes. In the fixed rate portion of your portfolio, this could mean having a combination of government and corporate securities, or a range of maturities (how long does the debt security have until the issuer repays it), so that you diversify your holdings sensitivity to interest rates and other factors. In the equities part, we believe this means owning a range of sectors and industries and preferably investing globally. In our view, this also means ensuring that a position in a single company is not much greater than that company’s weighting in a broad index such as the MSCI World Index. Owning only one or two companies in some of the smaller industries may be sufficient, but for larger areas like tech, industry, finance and others, we think it’s probably best to own some. many.
When you properly separate diversification and asset allocation, we believe it actually becomes easier to build diversified portfolios. Instead of adding marginal, hard-to-reach asset classes – some of which have lower liquidity and higher volatility, according to research from Fisher Investments UK – you can tailor a portfolio to your unique circumstances and then the complete with easy to follow, buy and sell titles.
Investors should not confuse asset allocation with diversified portfolios. Simply find the right mix of stocks, fixed interests and other securities for you – the one whose expected return and short-term volatility best matches your goals, needs and risk tolerance – then diversify- you by following these guidelines.
Interested in planning your retirement? Get our current information, starting with The Definitive Guide to Retirement Income.
Follow the latest news and market updates from Fisher Investments UK: