A portfolio refers to a diversified group of financial assets that are designed to generate maximum returns to the investor. In most cases, a portfolio’s goal is to generate these returns in an extended period of time. As such, people create these portfolios as part of a long-term investing strategy. In this article, we will look at some of the top strategies to use to optimize the performance of a portfolio.
Diversification is key
Diversification is the process of having multiple financial assets in a portfolio. The goal of having a collection of many stocks or bonds is to ensure that lagging assets are offset by outperforming ones. Indeed, some of the best-known investors have made a fortune by not placing their eggs in one basket.
Elon Musk’s biggest stock is in Tesla, but he also owns a sizable part of SpaceX. Similarly, Warren Buffet’s portfolio is made up of several stocks and cash.
Therefore, as part of optimizing your portfolio, you need to ensure that it is well balanced and diversified. Some of the top assets that should be in your portfolio are:
- Stocks – These are the most popular assets in the world. They refer to shares of companies that are traded on exchanges. Examples of stocks are Microsoft, Tesla, and Apple.
- Cryptocurrencies – This is a relatively new asset class that includes assets like Bitcoin, Ethereum, and Ripple.
- Bonds – These are debts of public companies, governments, and municipalities that are held by investors.
- ETFs – Exchange Traded Funds (ETFs) are diversified assets that are traded in the financial market. They are classified into active and passive funds.
- Commodities – These are tradable commodities like crude oil, gold, and silver.
In most cases, you should ensure that your portfolio is made up of some of the assets mentioned above. However, in some cases, you can have a single asset class that is diversified well. For example, you could have a portfolio made up of ETFs that track different assets. For example, you could invest in ETFs that track consumer durables, technology, consumer discretionary, financials, and energy stocks.
A popular way to diversify your portfolio is to have a mix of bonds and stocks. This is known as the 60-40 rule. This is where you allocate 60% of your funds to stocks and the remaining 40% to bonds. You can tweak this composition to meet your desired outcome.
Portfolio rebalancing
Another important aspect of optimizing your portfolio is known as rebalancing. Rebalancing is simply the process where you tweak the portfolio depending on market conditions. This means that you could add or remove some assets depending on what is happening in the market.
The actions of a central bank can help you in doing this. Let’s assume that you have a portfolio made up of 60% stocks and 40% bonds. When there is a major crisis, like the Covid-19 pandemic, the Federal Reserve will typically lower interest rates and even launch a quantitative easing program.
When the bank launches an easy-money policy, the implication is that stocks will do well. In particular, technology stocks that are viewed as being risky will do relatively well, while banks may disappoint. At the same time, bonds often underperform.
Therefore, in this case, you could rapidly rebalance your portfolio to meet the new normal. You could rebalance it by raising stocks to about 80% and 20% bonds. By doing this, you will be optimizing your portfolio by ensuring that it performs well in a period of low rates.
At the same time, when rates start rising, you could optimize it by doing it the other way around. In this case, you could load more finance stocks like banks since they do well when rates are rising.
You should also rebalance your portfolio when conditions change. For example, if a company you own changes direction, you should be willing to reduce its stake.
Add risk to your portfolio
The goal of a portfolio is to generate quality results. In most cases, you might be inclined to avoid risky assets in the fund. However, in my experience, I have noted that adding some risky assets to your portfolio can help it do well.
Cryptocurrencies are popular types of risky assets. It is not uncommon to see the price of a cryptocurrency like Bitcoin and Ethereum rise and fall by as much as 10% in a day. Still, in the long term, risky assets tend to outperform regular assets. For example, Bitcoin has jumped by more than 17,500% since 2015. At the same time, the S&P 500 index has grown only 120%.
Similarly, fast-growing companies are often seen as being risky assets. Besides, most of them don’t pay a dividend and are usually loss-making. However, historically, these stocks tend to do better than safe stocks like those that pay dividends.
Therefore, as you rebalance your portfolio, we recommend that you allocate some of your funds to these risky assets. However, because of how risky these assets are, you should add just a small portion of your funds to these assets.
Stress-test your portfolio
Another key aspect of optimizing your portfolio is to stress-test it. Stress testing refers to the process of simulating future events. There are two main types of stress-testing a portfolio. There is a predictive stress test and a historical stress test.
A predictive stress test is a process of envisioning a possible future state of the portfolio in different market conditions. A historical test looks at what happened in the past and applies it to a portfolio today. You should run a portfolio by examining the portfolio and risk factors, designing scenarios, and acting on future markets.
Summary
Optimizing a portfolio is an important thing to do because it ensures that you generate strong results when conditions change. In this article, we have looked at what a portfolio is, some of the top assets that are found in a portfolio, and some of the top strategies for optimizing it.
