The first step to building a sound investment portfolio is to know why you’re investing.
Setting measurable investment goals gives investors clarity and direction, and prevents them from falling into common investment traps like chasing unrealistic market returns or being overly influenced by transitory factors like product fads or short term performance.
Before you invest a single dollar, ask yourself what are your key reasons for growing your wealth – is it to fund retirement? Or perhaps work towards a house deposit? By establishing goals at the outset, investors can get a better idea of their time horizon and tolerance for risks – two important factors that contribute to developing the right asset allocation.
More is not always better
Without a plan, investors often build their portfolios from the bottom-up, focusing on each investment holding rather than the portfolio as a whole, and often lacking the diversification needed to adequately mitigate market risks.
Diversification is not necessarily about owning more securities, but rather the right mix of securities.
Investing in several bank shares instead of just one may help mitigate single security risk but concentration risk remains high given the single industry focus.
Similarly, investing solely in ASX-listed companies increases diversification across sectors but remains concentrated in the local market.
Remember, markets will often behave differently from each other—sometimes marginally, sometimes greatly—at any given time. Owning a diversified portfolio with exposure to different markets allows the investor to participate in stronger performing areas while also mitigating the impact of weaker areas.
Focus on what you can control
Lastly, two of the most important qualities to have when it comes to investing are not the ability to pick winning stocks or to perfectly time the market, but rather the ability to maintain both discipline and perspective even when conditions get tough.
These two qualities are instrumental in helping investors remain committed to their long-term investment plan through periods of market uncertainty.
While deciding on the right asset allocation is one of the cornerstones for successful investing, it only works if the allocation is adhered to over time and through varying market environments.
This means ignoring the temptation to alter asset allocations when markets are volatile and succumb to the appeal of market-timing, even when there appears to be visible winners and losers. This is because the opportunities that are clear in retrospect are rarely visible in prospect; investors cannot control nor predict what markets will do but they can focus on their own mindset and approach.
The above material has been reprinted with the permission of Vanguard Investments Australia Ltd