Developing an Investment Portfolio
Have you ever called your doctor and said…”I am sick, my goal is to feel better…call in a prescription for one pill to solve all my aliments.” That is what a lot of people do to me and other financial advisors in the investment arena. Their investments are not performing up to their standards, and, they want “one quick pill” that will solve their financial problems. Tell me, is there one pill to solve all your medical problems (aside form Dr. Kevorkian)?One of the most difficult tasks that individuals, and the financial advisors who advise them, face is choosing investments with characteristics that will help the individual meet his or her near and long term goals. While there are many courses that teach portfolio design, none can teach instinct and common sense. These two elements are ultimately the most important factors in developing an investment strategy.
Keep in mind there are 158 asset classes. The majority fall under the five categories below. Which asset classes you have, and, how much money in each asset class will totally depend on the Investment Policy you develop. From the Investment Policy you can construct your Asset Allocation mix.
It is generally felt that there are five basic asset categories in an investment portfolio. These are:
- Liquid Assets (Cash and Equivalents)
- Fixed Income (Bonds)
- Equities (Stocks)
- Real Estate (residential and investment property)
- Precious Metals and other tangible investments
Before allocating funds to each of these investment categories, it will be necessary to look first at the balance of the existing portfolio. Then, the actual percentage allocated to each category will depend on the person and his or her circumstances.
In assessing your circumstances, it is necessary to keep in mind certain asset characteristics. Assets are generally held for one of two reasons: personal use or production of current or future income. Since assets held for personal use are a matter of individual discretion, the focus is on those assets held for the production of current income or for potential appreciation. The asset characteristics to remember are:
- Taxability upon deposit, on income and at withdrawal
- Safety
- Growth and inflation protection
- Yield
- Liquidity
Each of the asset categories listed earlier can be evaluated according to these characteristics in order to decide what role each should play in the final investment portfolio.
Because there is NO single investment that possesses all of the above characteristics, a balanced investment portfolio will include a number of investment vehicles that together will contribute the needed characteristics. By spreading capital over many investments, you, as an investor, can reduce the overall risk of the portfolio. Investment capital should be spread proportionally over several different investments and among several vehicles within an asset category. The result will hopefully be a portfolio that produces the sought-after investment results and helps the individual to achieve his or her goals and objectives.
A related decision that must be made is how a particular asset will be held. Stocks for example can be held individually or by investing in a mutual fund. Individually held stocks can be managed by the investor or by a professional portfolio manager. Real estate can be in the form of a limited partnership, individual properties, mutual funds, REITS, or ETF’s. Many of these decisions depend on the degree of management and control the investor wishes to have.
Similar options are available for bonds, commodities and precious metals. Sometimes the choice of investment vehicle will depend on the amount of funds available.
COORDINATION WITH RETIREMENT PLANS
Many investors have over time developed substantial amounts of retirement assets. In developing an investment portfolio, these assets must be an integral part of the overall design. Current assets and retirement assets need to be considered together.
Sometimes assets that are considered suitable for the overall portfolio are better if held in a retirement vehicle.
When considering real estate limited partnerships, many investors object to their long term, illiquid nature. Given the long term nature of retirement plans, however, holding the asset in an IRA might overcome the illiquidity hurdle. An individual with 10 or more years to retirement could afford to hold the partnership for the period necessary to get the full economic benefits.