Global markets have been nose diving since the start of the year. Investors are rightly concerned about the kind of investments they should make, especially considering inflationary expectations. Creating a portfolio that is right for you can be very difficult, but in this article, I will explain what you need to do.
1. Determine a Financial Target
The first thing you have to do is to articulate what your required rate of return is. This will help you exclude asset classes or investment opportunities that cannot meet those targets.
You also figure out how much of your wealth you are willing to put at risk. So, for instance, if you are worth $300,000, what percentage of that are you willing to invest, and possibly lose.
2. Where Is Your Edge?
The truth is, despite all those Twitter screenshots, the typical investor makes a loss on their investment. So you have to figure out where your edge is. If you don't have an edge, then you can't win. As Warren Buffett once said, "If you've been playing poker for half an hour and you still don't know who the patsy is, you're the patsy."
You may not have an edge, but that doesn't mean you can't make any money. What it does mean is that you should "buy the market", which means buying a representative index fund that covers a broad section of the market. You can have a fund of the 500 largest firms in the country (the S&P 500), or of, say, the Russell 3000 Index which covers the entire U.S. stock market, or, an index fund that covers a specific industry, investment style, or other subcategory of the market. You can even invest in a fund of real assets such as property, or commodities.
3. Have a Margin of Safety
Many investors become so seduced by the prospects of an asset that they are ready to buy it at any price. What you need is a margin of safety, in other words, you need to buy an asset that is trading cheaply. For instance, if you are thinking about investing in gold, it's important to check the Dow-gold ratio: the higher the ratio, the cheaper gold is, and right now, the ratio is pretty high.
4. Diversify Your Portfolio, But Not Too Much
It's important to diversify your bets, so you don't overcommit. No matter how great you are, you can make a mistake. And even if you are right, any asset can experience potentially devastating losses. Here's an example: if a stock goes down 50%, you will need a 100% bounce just to get back even. You may be right about where an asset is going in the long run, but you need to survive the journey to make a profit on your bet. To do so, you need to be diversified so any downward volatility is compensated for with other assets. However, don't over-diversify: too many individual assets are costly to maintain and difficult to monitor. You should not have more than 15 different assets in your portfolio.
