I constantly think about what factors improve investing. I’m on a quest to codify good investing behavior. As I look back at my 20+ years of investing, I can think of about 4 factors that have improved my chances of a good return, regardless of asset class.
Diversification — Asset Allocation
Diversification is the key to reducing risk and volatility in a portfolio and to increase risk-adjusted return. The goal is to invest across a broad set of asset classes that are not correlated. Non-correlated assets classes are assets that do not react the same to market conditions. In a retirement portfolio, have some stocks, some bonds and some alternative assets.
Stocks are sensitive to an improving economic cycle. Bonds temper a portfolio’s volatility and do well in a fall-interest rate environment and during periods of deflation. Alternative assets, like gold and real estate, do well in inflationary environments. Therefore, diversification is key to an optimized return for the least risk taken.
Position Size
This is one of the three most important aspects in investing. I wouldn’t invest more than 20% in any one asset class and typically not any more than 15% in one specific investment. I like to keep investments between 5% and 15% of my portfolio. A standard position is 10%; sometimes, I have a half position and sometimes I have a double position.
I think what you’ll find with back testing is important to determine how your overall portfolio will behave. Investments need to play well with others, so it’s important to diversify and test your overall portfolio in a variety of conditions.
I’ve been hurt before by not properly thinking about position size. There was a time when I had 40% of my total portfolio in precious metals. That was unwise. And when the trade started going against me, the pain was real. When I lost 20% I started to re-size my portfolio (due to another tactic below), but I lost a lot more than I needed to.
I have a bunch of bets right now that should do well in rising inflation: some base metals, some precious metals. However, I don’t have more than 20% in metals. Same with cryptocurrency. I have a basket of cryptocurrencies, but I don’t want my total exposure to this asset class to be over 20%, period.
Many investment firms talk about not having more than 4% in any one position and diversifying across a minimum of 5 asset classes. An individual investor doesn’t have enough time or money to go to these extremes. In my opinion, I like to run about 7–10 positions in my investment portfolio, with some positions being a double position and some being a half position.
You want a position to be big enough that if it does well, then you see it in your portfolio return. When I used to run 20 positions, I rarely did well because my winners weren’t big enough, and running 20 positions meant I had 3–5 positions running against me.
So, I wouldn’t apply the advice of an institutional investor to an individual investor. Keep it 5%-15% for each position and try to invest in 7–10 positions.
For retirement accounts, I would have only 5–9 investments, just 1 for each asset class, but I would only use ETFs and mutual funds. Asset classes include Core Stock, Growth Stock, Developed Markets Stock, Developing Markets Stock, Alt Asset — Gold/TIP, Alt Asset — REIT/MLP, Bond — Government and Bond — Corporate. Maybe 1 more. I only use ETFs/Funds for retirement; I do not invest directly in stocks.
Setting Trailing Stops
When investing in stocks, trailing stops are key. These allow you to lock in gains and avoid big losses. A trailing stop limit order is designed to allow an investor to specify a limit on the maximum possible loss, without setting a limit on the maximum possible gain. A SELL trailing stop limit moves with the market price and continually recalculates the stop trigger price at a fixed amount below the market price, based on the user-defined “trailing” amount (usually a percentage). The limit order price is also continually recalculated based on the limit offset percentage. As the market price rises, both the stop price and the limit price rise by the trail amount and limit offset respectively, but if the stock price falls, the stop price remains unchanged. When the stop price is hit, a limit order is submitted at the last calculated limit price. Using trailing stops has been a key to not losing too much on any one investment position.
Automatic Dollar Cost Averaging
Dollar cost averaging is a strategy in which an investor places a fixed dollar amount into a given investment (usually stock) on a regular basis. The investment generally takes place each and every month regardless of what is occurring in the financial markets. As a result, when the price of a given investment rises, the investor will be able to purchase fewer shares. When the price of a particular security declines, the investor will be able to purchase more shares. Making this process automatic has allowed me to accumulate large, profitable positions in my investments. This works for investment portfolios, retirements portfolios and even cryptocurrency portfolios. I recommend setting a consistent amount to invest every month and making the process automatic.
Disclaimer: The above references an opinion and is for information purposes only. It is not intended to be investment advice. Please do your own homework.
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