Do-It-Yourself Investment Portfolio

by Kendrick Chua, RFP®

Ordinary investors often underestimate themselves and rely too much on market news and financial experts’ sage-like wisdom in managing funds. Truth of the matter is a do-it-yourself investment portfolio is not as complicated as you think. Listed below are the three steps that you can apply in creating a solid investment portfolio.

Before going down into the details, the term investment portfolio has solicited a sense of admiration from others whenever this word is dropped. Behind the “oohhs” and “aaahhhs”, what is it then? More importantly, what is the distinct advantage of creating one?

An investment portfolio is a combination of different financial investments designed to match the objective of investor. Think of it as a pie chart wherein each slice is a representation of one particular asset class. The asset mix you selected is based on how you want to achieve your particular goals you set out for.

The greatest benefit of an investment portfolio is that it allows the investor to spread the risk across different asset classes as he works towards his goals. This kind of diversification minimizes the risk of putting all the eggs into one basket. Nobody, not even the greatest investors out there, can precisely predict which asset class is going to perform well for a particular time. Without any crystal ball to do that, the best is to diversify that risk so that when one investment tanks, others top. In fact, studies have shown that a balanced portfolio has yielded better returns than investing in just one particular asset class.

Steps in building your own portfolio

1. Step One: Know your goal

   For others, using the word “dream” can be more motivating. But regardless of what word is used, it is about saving and investing for something in the future. Is it that dream home, fund for golden years, or the long awaited vacation? Whatever it is, one thing is certain: you need money.

   • Cost of goals.

     When you are already clear on your goal, the next process is quantifying it. How much would it cost to fund that? How much can you save for it? But whatever that amount is, one mistake to avoid here is not factoring inflation into account. The last thing you want to happen is discovering what you have painstakingly set aside is still not enough because inflation just made things more expensive.

   • Time horizon.

     Next, determine when you are going to need it. How much time before you need to access your funds for that goal. The longer you are from it, the more risk you can afford to take; hence, you can invest in more aggressive financial instruments that will yield better returns. But the reverse also holds true. The closer you are to your goal, the less aggressive you should be because volatility can work against you.

   • Risk tolerance.

     Lastly, always take into account the risk you can afford. All investments involve risk. Even holding cash has a corresponding risk (inflation leads to less purchasing power). Even though volatility smoothens out over time, not everyone has the appetite (and heart) to take those market swings. Consider the pillow test: when you can’t sleep at night, then don’t invest in it at all. What you want is to assume just enough risk to grown your portfolio but not too much that you cannot tolerate it.

2. Step Two: Allocate your assets

   Now that you have your goals all figured out, the next step is to find the investments that can help you achieve those. These investments should be in sync with your goals, and to do that you need to allocate the assets properly.Asset allocation is defined as how much percentage of your total portfolio you have in different investments— equities, fixed-income, cash, commodities, real estate, jewelry, and even antiques and collectibles.

   This could well be the next most important decision after establishing your goals. After all, how you balance your investments affects your goals entirely. And according to research, what securities to pick are only secondary to how you distribute them.

   The premise behind asset allocation is that not all investments move in the same direction all the time. Stocks could do well this year but bonds may not; and viceversa. A loss in one could be offset by the gains in other holdings.

   Investing within asset classes is also another option of diversifying your portfolio. Take for example stocks. Stocks can even be classified as blue chips or small-cap. The former provides stability and dividend income in a portfolio. On the other hand, the latter can appreciate much faster.

   • Calculating for the asset allocation

     How do you calculate how much to put in each asset class then? There is no hard and fast rule to this, but the younger you are, the more risk you can afford to take. One common advice is to subtract your age from 100, and whatever the difference is, that’s the percentage you put in stocks. So assuming you are 30 years old, 100 less 30 gives you 70. 70 percent is how much you should allocate in equities and equity-related funds.

     That doesn’t mean you go all out and immediately put that much in it. This percentage can be spread across a period, starting with a small percentage and gradually increasing it as you become more comfortable and savvy about it.

     What about the 30 percent? This can be spread among the other asset classes. One important thing that a lot of investors fail to see until it is too late is to maintain some cash positions. The cash is not the king for nothing. When the market corrects, having cash allows you to take advantage of dips and lets you increase your position in other securities. You are able to buy the assets at a discount, something you won’t be able to do if you are fully-invested.

     Case in point, during the 2008 global financial crisis, our equity market dropped as much as 60 percent. But that was the best time to buy, if you have cash. The market has gone by more than 250 percent since then, thereby tripling your money already.

   • Going beyond stocks and bonds

     While stocks and bonds are still the most popular asset classes, investors should also consider going beyond these two, and explore other options that can help them reach their goals.

     One asset class is commodity. Commodities are considered a hedge against inflation because their prices generally rise with inflation. Oil and gold are the more commonly invested commodities. As of this writing, oil is trading at US$92 a barrel, while gold is at US$1,662 an ounce. However, commodities are also very volatile. A sudden shortage in supply due to natural or man-made calamity can cause prices to drop dramatically.

     Real Estate Investment Trusts (REITs) are another investment worth considering, once they become available. REITs are tradable securities whose underlying assets are property portfolios that earn from income-generating real estate including office buildings, residential condominiums, shopping centers, hotels, warehouses, hospitals, airports, and tollways.

     A REIT is required to distribute 90 percent of its distributable income to investors in the form of dividends. Although the REIT Act has been passed in 2009, its issuance has hit a snag due to disagreement on the tax and ownership issues.

     Local investors can benefit from the booming real estate in the Philippines by participating in the ownership of these real estates; and earn from the constant dividends. Since REITs are also tradable in the exchange, investors can also benefit from the capital appreciation.

   • Going international

     Investors should also consider going global. Other emerging markets provide enticing investment opportunities not found locally. Consider the following returns of the five best performing exchanges of the emerging countries in 2012: Venezuela Stock Market 302 percent, Istanbul Stock Exchange 52.55 percent, Egyptian Exchange 50.80 percent, Karachi Stock Exchange (Pakistan) 49.98 percent, and the Nigerian Stock Exchange 44.65 percent.

     In Asia Pacific, the Stock Exchange of Thailand gained 35.80 percent against the Philippine Stock Exchange 32.95 percent.

     One of the best ways to get into the international scene is to invest in international funds offered by foreign banks and asset management companies. These emerging markets have been well received by investors because of the potential returns these countries have to offer.

     But there are risks to consider as well. The most notable risk in investing internationally is the political or economic instability especially among emerging markets. Then there is also the foreign exchange risk where fluctuating exchange rates can decrease the value of your investment.

     If investors are still averse into investing directly into commodities or even international markets, a structured note or structured product is an answer. Local financial companies have been coming up with a gamut of structured notes in the past couple of years, and this has well been received by the public. A structured note is defined as a zero-coupon bond that guarantees the principal but at the same time, provides an exposure to certain asset classes that are expected to perform very well.

3. Step 3: Reviewing and rebalancing

   Once you have laid out your portfolio, it is imperative you review your holdings regularly because movements in the market can cause some changes in your initial allocation. To assess your portfolio’s current asset allocation, divide the current value of a particular asset class against the value of the whole portfolio.To put things in perspective, supposed you started out with P500,000 with the current allocations: P300,000 in equities and equity-related funds (60 percent), P100,000 in bonds and other fixed-income instruments (20 percent), P50,000 in cash (10 percent), and P50,000 in commodities (10 percent).

   After a year, the equities gained 30 percent bringing your investment to P390,000. Bonds, on the other hand did pretty well with seven percent gain, making your bond holding worth P107,000. Cash in Special Deposit Account earned only 2.5 percent. Your cash position is now P51,250. Lastly, your commodity allocation fortunately gained 20 percent. Current market value is P60,000. Your initial P500,000 is now worth P608,250 for a total of 22 percent return.

   Your initial 60-20-10-10 allocation does not hold true anymore. Based on the market value of your portfolio, equities now occupy 64 percent; bonds with 17 percent; commodities is flat at 10 percent; while cash position went lower to eight percent. Overall, the portfolio gained 22 percent.

   At one glance, there is now an even more weight in equities than it had before. One option is to just leave it as is. If the equities do perform similarly, then leaving the whole portfolio untouched becomes advantageous. After all, the popular belief is that if an investment has performed well over the last year, it should perform well over the next year. However, in investing, there is always one caveat: past performance is not an indicative of future performance.

   This was very true prior to the 2008 financial crisis. The year before, equities still posted double-digit return. We all know what happened after. Again, nobody can predict what will happen but the best way to prepare for any uncertainty is to be prudent with your fund management. Investing is not just after the returns, you should always consider managing the risk as well.

   If you are to be religious in your asset allocation, then you can rebalance your portfolio in such a way that the weight of the asset classes is still the same. In this case, you need to deduct P25,000 from the equities and distribute them to bonds, commodities and cash. In doing so, your new portfolio is as follows: P364,950 in equities; P121,650 in bonds; P60,825 in commodities; and P60,825 in cash.

   Your equities still maintain the 60 percent share but this time, its value is higher than a year ago. The additional P64,950 allows you reinvest your earnings. Another advantage is that you also increased the value of your cash position, while still maintaining the same weight.

   How does this help? When other asset classes drop in value, you have much more ammunition to take advantage of the dips and buy shares at depressed prices.

   Throughout managing your funds, you need to also periodically assess your goals, time horizon and risk tolerance. As mentioned earlier, the closer you are to your objective, the less aggressive you need to be, and start pocketing the gains you have already earned. In between, you could also add other asset classes that you think can help you bring you closer to your goals. Overall, a balanced investment portfolio is your best bet to achieve long-term financial success.