Constructing a strong investment portfolio may sound like a gigantic task for most of us. An investor’s personal characteristics, portfolio size, or risk tolerance may jointly affect their stock preferences, making investing a time-consuming and challenging process. It can feel like juggling a dozen balls with just two hands.
Here are two points that I would like to share with investors with respect to constructing and maintaining a healthy portfolio.
Sectoral diversification
Investors often hear that one of the most important investing rules to remember is to diversify. To put it simply, diversification is all about reducing risk.
Diversification will not eliminate all the risk in your equity portfolio. But your long-term risk/return ratio is likely to be more attractive. Many seasoned investors realise how important it is to watch out for your downside and let the upside take care of itself.
I approach diversification both sector-wise and internationally.
First it is important for investors to hold shares from a mix of industries so that a downturn in any one industry does not hurt the portfolio too much.
For example, a big drop in the price of oil might hurt you if you were invested in oil giant BP.
Yet if you also held shares in International Consolidated Airlines Group, the owner of British Airways and a company where the largest variable expenses are fuel costs, you might have found that the potential appreciation in the IAG share price goes a long way to offsetting the decline in BP shares.
And when you add the current dividend income from holding the shares of both companies, then you may find that the volatility in the market may not necessarily be so difficult to navigate.
But two companies only do not make a diversified portfolio and exchange-traded funds (ETFs) or a FTSE 100 or FTSE 250 tracker fund could be the way forward.
With its current dividend yield of about 4.5%, the FTSE 100 could be suitable for passive income seekers. On the other hand, FTSE 250 is likely to offer more in the way of average annual growth.
Geographic diversification
Fortunes of different countries do not always move together. Therefore, look beyond our borders too. If you are interested in US shares, but are not sure which ones to include in your portfolio, then you may consider an ETF such as the iShares Edge MSCI USA Quality Factor ETF.
This ETF holds large- and mid-cap stocks that have exhibited stable year-on-year earnings growth, such as Apple, Exxon Mobil Corp, Facebook, Johnson & Johnson and Visa. Although Wall Street analysts are debating whether the US economy might be set to slow down in 2020, US-based quality shares are likely to provide growth for many long-term portfolios.
Global diversification could also enable investors to ride out the effect of currency fluctuations. For example, since the 2016 Brexit referendum, the pound has dropped sharply in value against other major international currencies.
For those investors who feel overwhelmed by the volatility in the pound in the short run, I think an ETF to consider could be the FTSE All-World ETF, tracking the performance of a large number of stocks worldwide. By having global exposure too, UK-based investors may be able to decrease the short-term adverse effects of the home bias in these uncertain times.
