Understanding the importance of an investment portfolio's asset mix is quite possibly one of the toughest hurdles for investor's to get over.
But once investors realize that asset mix is not only a defensive measure to protect against downside risk, but a way to ensure that at least part of their capital is available for more aggressive, high opportunity positions, then adopting an appropriate asset mix is usually something that most people agree to do.
The problem then comes down to knowing how to construct the ideal portfolio.
How much in cash, how much in bonds and how much in equities (as well as other specialty asset classes).
Luckily, building a proper investment portfolio need not be an overly difficult and challenging experience.
One way to perfect the art of portfolio building is to start off with a 100% equity allocation, then scale it back depending on how one feels about the following considerations: 1.
How liquid should my portfolio be? By assuming that core equity investments will take up 3-5 years of your portfolio's lifespan, question how much of your assets you can ignore for this period of time.
In some cases, particularly when starting out, investors will only be comfortable allocating a small amount of assets to a 3-5 year commitment.
The balance of the assets will then go into more liquid, higher-income producing investments.
2.
How much of my "ideal" portfolio should be liquid? If starting out, it makes sense to have a small amount invested in 3-5 year equities.
But how much of the ideal portfolio should be in equities given your time horizon, risk tolerance and investment goals? If there is a big gap between how much is invested in equities and how much should be invested in equities, you will likely want a greater Cash component so that in the short-term, you can easily access capital to make choice, longer-term investments.
If the amounts are close, then you will be putting more into income-producing assets that you can hold in the mid-term.
3.
What are interest rates doing and what they expected to do in the near future? In periods of high interest rates, that 100% equity portfolio is likely to very easily reduce to less than 50% if the expectation is that interest rates will start dropping.
Not only can higher rates reward investors with healthy income levels but a period of dropping rates will also rewards that same investor with gains on bond prices...
normally in periods when equities are dropping.
As shown in the above, starting out with a 100% equities and working your way down to an appropriate asset mix makes sense.
Taking a good hard look at how the above affect you individually helps to reduce that equity component to an appropriate level.