The final blog in this particular series will be by far the longest because this is where the rubber meets the road, so far as you being able to create the life you want. There are many schools of thought on what is the best way to create a well-diversified portfolio. Many investors say, “Never put all of your eggs in one basket,” whereas Warren Buffett says, “Put all your eggs in one basket, then watch that basket very carefully.” Unless you’re Warren Buffett though, or have his incredible analytical mind, then you should pretty much rule out his strategy.
To give you an idea of what I believe to be a well-diversified investment portfolio, I have broken down my own portfolio, which I modelled on an “All Weather Portfolio” that Ray Dalio provided to Tony Robbins, in his book, “Money, Master the game”. I have changed it to suit my own needs and just like Ray, I am confident that it will cope much better than many other types of portfolios; in all markets.
This is what my portfolio looks like:
- 19% – Cash
- 15% – Australian shares ETF (ASX200)
- 7% – International shares ETF (Worldwide – excluding USA)
- 7% – USA Small cap (individual company)
- 7% – USA Large cap (individual company)
- 12% – R.E.I.T
- 9% – Bonds (ETF)
- 7% – Gold (individual company)
- 7% – Resources stocks (individual company)
- 10% – Healthcare stocks (individual company)
This portfolio gives me a great mix of assets across different asset classes, with varied correlation, which will see my portfolio weather almost any situation. The benefit of this portfolio, is that while I may miss out on the highest of gains occasionally, I will be less likely to suffer the worst of losses, as a result. This type of portfolio has been back-tested over 100 years, by Ray Dalio, who founded Bridgewater Associates and it has outperformed the market in all types of bearish or bullish markets.
So, let’s break it down.
1. CASH / CASH EQUIVALENTS – 19%
I strongly recommend that you hold at least 10 – 20% of all your total portfolio in cash. Firstly, this is for safety, should you suffer a loss through a stock market crash, or a downturn in the housing market. 10 – 20% in cash, is an absolute minimum, because if you’re working towards an investment plan (which everyone should have), then you will more than likely have extra cash on hand, depending on the market at the time. I currently have closer to 40% in cash at the time of writing this, because we are going through a sustained “bull market”, so the majority of shares are way over priced and not worth buying (in my opinion).
I have this cash on hand, so that when the market takes a correction, or a crash (which will happen), I am ready to pounce and buy some undervalued stocks. For the past five or six years, Warren Buffett has had billions of dollars in cash reserves, because he too believes that most stocks are overpriced.
2. DOMESTIC SHARES – 15%
For most investors, I recommend using predominately low-cost “index funds” for some of your investment portfolio. Index funds, or ETF’s (Exchange Traded Funds), are funds that “mimic” certain categories of stocks, to obtain comparable results.
For example, if you want to invest in every company listed on the American Stock Exchange (N.Y.S.E), it would cost you millions of dollars. An easier and cheaper way, is to invest in an index fund, that mimics the “Russell 3000”, which is every stock listed on the NYSE. Companies such as Blackrock investments or Vanguard Investments, have such index funds and for a very small investment, you can have access to all of these stocks.
The reason for me recommending index funds over “managed funds” is for the following reason. Index funds have much lower fees than managed funds and while you may not think that a 1% or 2% will make much difference, I can assure you, that over twenty years, it could be a difference of hundreds of thousands of dollars. The 15% that I have in Australian shares, is in an index fund that mimics the ASX200, which is the index monitoring the top 200 companies listed on the Australian Stock Exchange. It is much cheaper to purchase and has very low management fees, so it’s a great option for everyday investors.
Vanguard Investments, Blackrock Investments and BetaShares, all have a good varieties of index funds that cover most asset classes.
Vanguard: www.vanguardinvestments.com.au
Blackrock: www.blackrock.com/au
BetaShares: www.betashares.com.au
Like anything that you buy, you must do research on any investment product, so that you fully understand it, before making a decision.
While I personally like these funds, this investment advice is general in nature, so I strongly recommend that you talk to an investment advisor or do your own thorough research before purchasing any product.
3. INTERNATIONAL SHARES – 7%
Inside your portfolio, I recommend having a mixture of domestic and international shares. The Australian and US markets do share some common influencing factors and can move in the same direction; however, they are separate identities and generally move at varied rates. This is why I have a mix of both domestic and international shares through index funds, to spread my risk, while giving me exposure to different markets around the world.
As well as domestic shares, I have 7% of my portfolio invested in international shares. This is by way of another index fund, that follows the worldwide index; excluding USA. This index fund includes every market around the world, but not the USA. The reason why I have kept the NYSE (New York Stock Exchange) separate, is the NYSE moves differently to the rest of the world.
4. USA: Small Cap – 7%
5. USA: Large Cap – 7%
When it comes to US stocks, I have broken them up into small cap and large cap stocks, of which I have 7% of each. My recommendation on this, is because the N.Y.S.E, is one of the biggest markets in the world. It is therefore, one with a lot of potential for growth. On the other side of the equation, it is also the one, that could be most affected by volatility. It is for these reasons, that I recommend, further diversifying into small and large cap stocks, so you can benefit the most.
Small cap stocks are companies that have a market capitalisation of between $300 Million to $2 Billion. Small cap stocks, historically tend to grow faster than large cap stocks, but tend to be more volatile. Large cap stocks are companies with a market capitalisation of $10 Billion or more. Large cap stocks grow more slowly but are far less volatile. Large cap stocks are like the main meal, while small cap stocks are like dessert. The main meal is nutritious and good for us, but we all want to fill up on dessert. Truth be known that if we do, we might explode; just like your portfolio. That is why I recommend a mix of both, so you can have the best of both worlds.
In the money chapter of my book, “Create the life you want” I go into great details as to the best analysis and ways to choose great stocks, at bargain prices.
6. R.E.I.T’s – 12%
My next 12% of my portfolio, is invested in R.E.I.T’s.
A R.E.I.T is a Real Estate Investment Trust and is a stock (or index fund) that invests in real estate. This can include, commercial, industrial or residential property; or a combination of all of them. It is recommended that every portfolio has some type of real estate investment, for diversity. R.E.I.T’s are completely different from other shares, because they invest predominately in property, so therefore react to market fluctuations differently to other domestic or international shares. R.E.I.T’s can be invested in as individual stocks, or through an index fund, same as other shares that you can buy. The returns on REIT’s tend to be much higher than bonds and cash, but they are more stable than shares.
7. BONDS – 9%
I recommend 9% as a minimum for bonds in any portfolio. Bonds move very differently to stocks and R.E.I.T’s, so there are an important part of having a “safe” portfolio. Most investors who are entering into their retirement years will hold anywhere from 50% – 80% in bonds. Bonds will not provide the same level of returns as shares, or REIT’s, but they will provide much more stability to your portfolio.
If you wish to look further into bonds, I highly recommend doing more research. A great place to start is http://www.asx.com.au/products/bonds.htm
While bonds, are more stable that stocks, they don’t have the same potential growth (or loss) as stocks either. While stocks may grow by 12% – 30% in a year, bonds may only grow by 2% – 5%. On the flipside, stocks could decline by 20%, whereas bonds, will only decline by 5%. It is for these reasons, that I strongly recommend that you hold bonds as part of your portfolio. I have chosen a simple approach to investing in bonds. I have my 9% invested in a bond index fund. This fund takes a stake in a large variety of bonds, that spread across Australian treasury and government bonds.
8. Gold – 7%
9. Commodities / Resources stocks – 7 %
In Tony Robbin’s “Money, master the game”, Ray Dalio explains that he recommends having a mix of Gold & Commodities in a portfolio. To some investors, gold is something shinny that does nothing, but to others, it’s an important piece of the puzzle. Because commodities prices usually rise when inflation is accelerating, they offer protection from the risks of inflation.
In my portfolio, I have 7% invested in a Gold producing company and 7% invested in a Resources index ETF. I used the same formula that I used to pick small and large cap stocks, (detailed in Create the life you want) to find a suitable under-priced company than is in the gold sector, while I kept it simple, so far as resources, by choosing a low-s cost index fund.
10. HEALTHCARE – 10%
For the last part of my portfolio, I have allocated 10% to healthcare stocks. With the aging population around the world, this sector, is one that looks to be on the rise, well into the future. When choosing a suitable healthcare stock, I used the same formula for choosing shares, that I explain in detail in “Create the life you want.” If, however, you want to take a most simplistic approach, there are once again, index funds (ETF’s) that can give you exposure to this sector, for very little cost.
All the pieces of my investment portfolio are either great value companies, or low-cost index funds, all of which I can buy or sell myself, on my online trading account. When I started investing, I had no idea how I could start. I had enough information that I knew what I wanted to buy, but I had no experience as to how to buy them. My advice is to dedicate a little time each week to learning about the market. Like anything in life, if you want to be good at something, you must dedicate time to it. As I mentioned in my previous blog “Take an interest in all things money” there are some great books on money and investing. I have a full list of recommended reading, on my website here.
Remember, we all make mistakes when it comes to investing, so take your time, do your research and if you screw up; learn from it. Another great way to learn about stocks, is to get familiar with some of the free websites, such as Yahoo Finance, MSN Money and Google Finance. All of them are free and they have all the information you need to get started. I also recommend, subscribing to The Wall Street Journal or The Financial Review in Australia. Watch as many videos on YouTube and download all the podcasts that you can find.
I hope this series of blogs on finance have helped you to Create the life you want. If you have any questions about any of these blogs, I’d love to hear from you, via my contact page on my website www.jdmoorea.com
