Unfortunately, many investors cannot resist investing in every new idea that is likely to turn the world upside down. How to determine if your portfolio is an example of careful diversification or promiscuous dispersal of funds? Here is five questions you should ask yourself before investing any assets.
Are there any investments incomprehensible to you in the portfolio?
This does not mean a vague idea like “Well, yes, this is an exchange-traded fund with borrowed funds that generates income twice as high as S&P 500” or “This is a variable annuity that gives 7% per year.” The point is that it is necessary to understand exactly how the income that you get by attracting credit funds is calculated (this determines how much this asset will bring), and what exactly the guaranteed 7% refers to. If you do not know how the investment works, it is impossible to understand whether you need it.
Are the fingers of one hand enough to count all your investments?
There is no factual “right” number of investments in which it makes sense to invest. But as soon as there are more than five or six of them, many of them are likely to intersect, or you are sure to invest in insufficiently reliable assets that you do not need. The truth is that you need just three index funds to sufficiently diversify the assets in different countries: a fund of shares issued in the USA, the fund investing in bonds issued in the USA, and the index fund of shares outside the USA. Check if there is any intersection of investments, that is, a situation in which you own the same shares in different packages.
Can you accurately explain the reasons why you have invested in each of your assets?
If you were talked about it on a TV show dedicated to investments, or if a magazine included it in the list of “The ten most successful investments”, then this is not what you are looking for. In addition to understanding how the investment works, you must be aware of its role in your portfolio and in making it better. Ideally, you should be able to express the income received from this asset in numerical value by quoting the results of the research or citing financial indicators that demonstrate how it improves the balance of risks and profitability.
Do you have investments that you have never touched after investing?
If you follow a long-term investment strategy, the mix of the assets in the portfolio should include, for example, 50% of the shares of large companies, 10% of the shares of small companies and 40% of bonds, i.e. it should reflect your investment goals and be risk-proof. Since different investments bring different incomes, you need to periodically check the balance and restore the correct proportions. To do this, it is necessary to sell some profitable shares and redirect the proceeds to not so profitable assets and / or additionally invest in those investments that have brought lower income. But if you have assets from you never withdraw funds from and never invested in them additionally, this suggests that they are not part of the rebalancing process, nor an integral part of your investment strategy.
Do you regularly add new assets to your portfolio?
If your answer is yes, it is possible that this activity is not good for the portfolio. By creating a well-balanced portfolio, you can consider your work done. Of course, it is necessary to monitor and rebalance the assets and, possibly, sometimes to sell not the most successful investments, replacing them with another asset that would perform the same function (this situation can be avoided with the help of index funds). But there is no need to constantly add new classes of assets or invest simply because investment companies offer regular investment opportunities. By doing so, you increase your chances of becoming the owner of a large number of odd investments, which are much more difficult to manage than a simple portfolio in which the degree of risk and return are effectively balanced.