The following is an edited extract from Ditch the Debt and Get Rich by Effie Zahos. Effie Zahos is one of Australia’s leading personal finance commentators, with more than two decades of experience helping Aussies make the most of their money.
Building a portfolio is a lot like putting together a wardrobe of clothing. It’s surprising how much the two have in common.
Some investments will be evergreens that you’ll want to hold on to for ages (just like those designer heels). Others will be selected to meet different needs (much like workwear or activewear). Importantly, your portfolio, like your wardrobe, should reflect who you are in terms of your goals, needs and life stage.
The main point is that if you can put together a decent wardrobe, you can certainly build a portfolio of investments. Here’s what to look at.
3 Key Factors to Consider
When you first set out as an investor, it can be confusing deciding which investments to include in your portfolio. Three factors can help to narrow down the choice.
1. How You Feel About Risk
One of the main issues that should shape the investments you select is how you feel about risk.
All investments come with some sort of risk, so it’s not something you can, or even should, try to avoid altogether. It’s about finding the level of risk you are comfortable with. That said, the lower the risk, the lower your returns will be. And, if you want to earn higher returns, be prepared to take on more risk.
This risk-return trade-off is one of the ground rules of investing. You could, for example, play it safe by only investing in cash-based assets like savings accounts. The drawback is that you’ll earn some very ho-hum returns.
Further along the scale are fixed-interest investments like government and corporate bonds, which have slightly more risk, but also the potential to deliver better returns. Both property and shares have a higher level of risk again. The pay-off for taking on that extra risk is the prospect of earning better long-term returns.
At the far end of the spectrum are speculative, or ‘alternative’, investments. These tend to be complex and extremely risky. I’m talking about things like futures, foreign currency and even cryptocurrencies like Bitcoin.
2. What You Want from Your Investments
Next, think about why you are investing. Are you hoping to earn extra income; do you have a goal you’re working towards like paying for your kids’ education; or are you simply aiming to grow long-term wealth?
If you’re looking for additional income, for instance, a term deposit can tick the box. The trouble is that the value of your money won’t grow over time. So, it could pay to add shares to your portfolio. Dividends can be a source of regular income, and you’ll also have the potential for capital growth as your shares rise in value over time. The bottom line is to look for the combination of investments that meet your needs and help you achieve your goals.
3. Where You’re At In Life
Your life stage can be the final clincher that shapes your portfolio. As a general rule, we can afford to take on more risk when we’re young, and steadily dial down risk as we age. It’s a view based on the idea that as we get older, we have fewer years ahead to recoup any losses.
Mix ’n’ Match – Why Diversifying Matters
There are no set rules about what your portfolio should look like. But one thing’s for sure: it makes a lot of sense to spread your money across a variety of investments. This is called ‘diversification’, and it works in your favour by reducing your portfolio’s overall level of risk while smoothing out returns.
It’s an effective strategy because investment markets don’t all behave in the same way at the same time. When sharemarkets are up, for example, the property market may be down. Or when returns on cash are high, shares may be in the doldrums. Spreading your portfolio is a proven way to reduce risk without sacrificing healthy long-term returns.
For the record, diversifying doesn’t mean simply investing across a number of asset classes. It’s also possible to spread your money around different markets. When it comes to shares, for instance, investors can diversify across companies, industries and even geographic regions.
What’s the Ideal Blend?
I mentioned earlier that your portfolio will be as unique as you are. And it should certainly reflect your appetite for risk, your investment goals, and your life stage, which means that deciding the right mix of investments for your portfolio is a very personal issue. If you’re completely stumped, a professional financial advisor can recommend a portfolio tailored to your needs, though this will come at a cost.
Another approach is to follow the lead of professional fund managers, including super funds, which often build three main types of portfolios: conservative, balanced and growth.
The 5 Must-Knows
1. Personalise Your Portfolio – Do Not Copy Someone Else’s
We have all met those ‘experts’ who insist on sharing stories about how they’ve made huge returns on their investments. You are not one of them. You wouldn’t copy someone else’s wardrobe, so don’t try to replicate someone else’s investment portfolio.
2. Follow a Plan, Not Your Emotions
When it comes to investing, there’s no place for FOMO or ‘gut instinct’. Know what you’re aiming for, stay focused on your goals, and don’t let knee-jerk reactions shape your portfolio.
3. Include Growth Investments
Over a period of 30 years, inflation of just 3% can reduce the purchasing power of your money by more than 50%. That means growth investments can play a valuable role in your portfolio at just about every life stage.
4. Don’t Rely on Past Returns
No-one can predict how asset markets will move and last year’s winning investment often becomes this year’s also-ran. Pick investments that you believe are right for you rather than focusing on yesterday’s chart-toppers.
5. Nothing Stays the Same
Life doesn’t stand still for long and you could experience any number of twists in the road: a career change, the end of a relationship, a big promotion, maybe even redundancy. So, chances are that your portfolio will need a few course corrections over time.
In fact, it’s a good idea to take a look at your portfolio at least annually to be sure it still ticks all the boxes for how you feel about risk, your goals and where you’re at in your life.
That’s different from continually tinkering with your portfolio. But a steady, planned approach will help you maintain the mix of investments that remains right for you over time.
Ditch the Debt and Get Rich by Effie Zahos is available now at leading book stores for $29.99.