Establishing an investment portfolio can be likened to building a home. The most destructive, yet unpredictable, weakness to the structure of a home is the weather. Even in these most technically advanced days, we are still unable to accurately predict the weather.
And so too, a person is foolish if they think they can successfully predict the future of the global economy. Like the weather it can be the most unpredictable and destructive threat to your investment earnings. But with a carefully built portfolio based on sound foundations, you have a much better chance of weathering a financial storm.
Investment principles
The foundations of a strong portfolio rely on four key ‘pillars’ or investment principles… quality, value, diversity and time.
We are probably all tiring of the old line, “don’t put all your eggs into one basket” – meaning to diversify your portfolio – but that is only one pillar on which to rely. The other three are equally important. Forget about just one and you are setting yourself up for a collapse.
Why all four pillars are crucial
If we look at the first two pillars, quality and value, it’s obvious this means to look for assets that are expected to provide higher returns relative to their risks. Applying this to shares, quality companies should have a sound basis to their operations and growth; that is, their earnings are not driven by fads. This, however, might mean they take time to deliver. Remember that investing in the share market is generally a long-term strategy.
Quality and value don’t always go hand in hand. Quality stocks may trade at such high prices that they offer low initial value, or it could be that expectations for these companies are sometimes too high. The key here is quality… the expectation is that they will be around for a long time, not just a good time.
This takes us back to diversity. Diversity acts like the scales in a portfolio, providing balance. True diversity in a portfolio gives the investor the opportunity to take advantage of “hot stocks” or asset classes, whilst balancing out the risk with quality stocks and asset classes. It can provide a buffer against mistakes in assessing value because nobody gets it right all of the time. A well-balanced portfolio should be designed cope with occasional losses.
And finally, the pillar of time applies to the previous three. It can give you the best chance of success. Every market will suffer periodic downturns, however over time the upturn will always triumph. The golden rule is don’t panic and get caught up in the fear and greed cycle. Make sure your investment portfolio is based on solid foundations. Talk to us today!
