A good investment portfolio should do a few things right. Failure to do any one of these things means the portfolio is not truly achieving your investment needs.
In fact, anytime you face a decision on what to do with your money, apply this litmus test. Can the investment:
- Keep my money safe
- Let me sleep at night
- Generate decent profits
- Be simple and easy to understand
- Not cost too much in fees/overheads
If any of these statements is not true, you should probably question the investment, or at least ask yourself if it’s worth it. We’ll break down each of these requirements below.
1. Keeps your money safe
What good is a strategy or portfolio if, in the end, you end up losing money? A good strategy must ensure your capital is protected. Simple right?
This requirement is overlooked way more often than you’d think. This is usually due to human greed or by us simply being blinded by the tremendous potential profits (see #3). Remember risk vs. reward?
Mind you, a portfolio’s investment strategy doesn’t need to protect your capital each and every year! After all, we invest for the long term. It just needs to do so throughout the total lifetime of your investment. This could be 20 years or so.
In other words, when all is said and done and you are about to retire, you should be confident that your strategy ensured short-term losses & fluctuations eventually recovered. You should be sure your total portfolio value is not lower than what you started with.
2. Manage volatility according to your needs
Volatility needs to be controlled. It needs to be acceptable based on your life goals, investment objectives, and risk tolerance. The amount of volatility you’d be okay with at 25 years old is probably a lot higher than what you’d be okay with at 40.
Where you are in life, your responsibilities, and financial commitments also impact how much volatility you can withstand. Expecting kids? About to get married? Leaving your job to start an MBA? All of these are life events that force you to be a little more conservative.
A good portfolio offers you just the right amount of volatility. Not more, not less.
3. Generate good returns
We all want to see our net worth grow. It’s not good enough for an investment to have decent volatility and protect our starting capital. It needs to grow our starting capital.
As we talked about in this post, your goal as an investor is to let your portfolio work for you. Your returns every year should be as high as possible while keeping your money safe and managing volatility according to your needs.
Doing so means a strategy is effective and is doing what we need it to do.
4. Be simple
We are busy people. We have jobs, hobbies, friends and lives. Surely we can’t be expected to spend all our time studying complicated investment strategies and managing our money. After all, we want our money to work for us, not the other way around.
Any strategy that seems too complicated to manage, or is too difficult to explain or understand is, quite simply, not simple enough.
The simpler a portfolio is the more likely it is you will commit to the strategy behind it. That in turn makes it less likely you’ll make bad decisions and mistakes.
5. Not cost too much
Just like parking and insurance, it costs money to make money. Portfolios also have costs, which we’ve discussed in our stocks, mutual funds, ETFs, and indexes post.
Making money can cost a fortune (if you let it), but it can also be quite cost-effective if you are careful about it.
A good investment strategy or portfolio must lower its background investment costs as much as possible. Doing so effectively means your costs will not eat into your returns, you will make more each year, and you will achieve your goals faster.