In our opinion, these are the building blocks of successful long-term portfolios. At the very least, these two concepts give investors a starting point for designing their portfolio. While we believe portfolios should be much more sophisticated than this, we don’t argue the importance of both Diversification and Risk Tolerance
Fundamentals of Foundational Investing
The word diversification has become a sort of buzz word in the asset management industry, and you’ll likely hear it from most investment firms (or at least you should). Most people know diversification as “don’t put all of your eggs in one basket.” The key to diversification is that by not overly concentrating your investments (think owning a single stock), you can create a more efficient portfolio. A more efficient portfolio allows you to reduce your risk/volatility while not sacrificing expected rate of return. This simple concept can produce better long-term risk-adjusted returns.
There was a time when everyone was recommended the 60/40 portfolio (referencing 60% stocks, 40% bonds). Times change and that default recommendation is archaic. Investors should have a solid understanding of their risk tolerance, which includes both their willingness and ability to take risk. By going through a thorough exercise to examine these areas, a portfolio can be created using a more thoughtful approach to investing. Think about it, if one doesn’t know how much risk they need to take or the type of experience they’re comfortable with, it’s pretty difficult to design a prudent portfolio. Understanding one’s risk tolerance is vital.