The US market has gone through numerous crises that depleted the wealth of many Americans. The Great Depression, the dot-com bubble, the Real Estate Bubble, and the Great Recession were some notable examples.
And even a decade after the 2007-2009 crisis, millions of individuals struggled to regain and bounce back. In 2020, things became more shocking when the pandemic came and led to business shutdowns and mass layoffs.
Amid all these, Americans became more aware of macroeconomic changes. Given the increasing inflows in the capital market, they became more interested in financial markets. Now that more alternatives exist to the stock and bond market, more people are joining this trend. So, it’s no surprise investing has produced many millionaires in recent years.
Even so, beginners must be aware of the risks associated with every type of asset. That is why considering factors such as capital, liquidity, and risk appetite is essential. Assessing these things can help investors manage risks and returns. Hence, this article will help readers build the right portfolio management strategy.
Choosing the Right Portfolio Management Strategy
Investing can be rewarding but comes with risks at varying levels. As such, investors must consider these before opening an investment account.
Capital
Capital is the most crucial factor on the list. With it, investors can open an account at any trading platform. Investors must also study different investment types and platforms since their capital requirements may vary. They must also have adequate capital before starting to have a fallback position should they make a wrong move. Given their volatility and sensitivity to economic changes, this is especially essential in the stock and forex markets.
Suppose an investor decides to enter the stock market and picks a trading platform with a minimum capital requirement of $1,000. It may be wise to have at least $1,200. These include 20% in contingencies, especially during price corrections and even crashes. That way, you can have an extra amount to recover from investment losses or devaluation. You can use the whole amount for trading without worrying about the unfavorable impact of market swings.
Liquidity
Liquidity is another essential consideration for investors since it determines how easy or time-consuming it can be to buy and sell investments. It also shows how long it will take to convert investment gains into cash.
For instance, investors want to buy and sell investments and generate gains relatively quickly. Bonds are often out of the question since every detail is fixed upon release. These include their price, yield, and maturity date. Common bond offerings are those maturing in no less than 90 days.
Stocks are relatively liquid since buying and selling can be done instantaneously. However, forex is the most liquid investment option. Aside from swift transactions, traders realize yields much faster than stocks.
Goals
No matter how old and wherever you are, it is a must to understand your end goals for opening an investment account. Do you want to have a stable source of income upon retirement? Do you want to have passive income while working? Is earning thousands or millions of bucks in an instant to retire early your goal?
Mutual funds and annuities are excellent choices for those nearing their golden years. Having these ensures a constant income stream upon reaching retirement age. Meanwhile, forex can earn you thousands or even millions of dollars in the wink of an eye. But risks are much higher that they can deplete your wealth, especially during a crisis and/or correction.
Risk appetite
Your goals should always work hand-in-hand with risk appetite. The financial market has been through numerous crises that exhausted a considerable chunk of capital in just a snap. So, you must always watch every market and economic change closely.
Bonds can be your perfect choice if you have a high risk aversion. All details will already be fixed once the issuers release them. Yields and maturities are already indicated in the paper once you buy it. So, market swings and macroeconomic changes cannot increase or lower its value.
You will not have to worry about losing capital, making it a secure investment. Also, the issuers are the government and large corporations, so payment defaults are almost impossible. The only drawback is its low yield and the inability to appreciate.
A balanced fund may be a perfect fit for you if you want higher returns but prefer to be conservative. This is a combination of various investments in a single fund. For example, you can have a fund manager or invest in a brokerage firm. They will allocate your capital between bonds and equities or stocks. The percentage may vary with your preference.
But riskier assets may be exciting for you if your risk tolerance is high. Equities are the most popular investment types, given their high returns.
Diversification strategy
Now that you’ve identified your risk appetite, it’s time to create your diversification strategy. You may wish to invest entirely in bonds to ensure low but secure yields or in equities to generate higher returns. Either way, it is essential to understand the upside potential and downside risks of every asset type.
Investments for Beginners
As you start your investment journey, you may first be overwhelmed with various investment types. As a newbie, you want to do it right the first time, especially now that prices and interest rates are still elevated.
But given your capital, liquidity preference, goals, risk appetite, and diversification strategies, you may already have a solid choice. We will narrow the list to five investment options to help you with your investment strategy.
Mutual funds
Mutual funds pool assets from shareholders, which may be invested in various financial instruments. These are allocated to these investments by mutual fund managers and/or investment advisors in a managed or self-directed brokerage account to derive capital gains.
For instance, they can split it between stocks and bonds or whatever ratio matches investors’ risk appetite. As such, they can optimize their risk-reward management.
They structure and align the portfolio with the mutual fund’s objectives reported in its prospectus. These categories show the securities it invests in, investors’ risk tolerance, objectives, and returns.
One of the advantages of a mutual fund is its accessibility to professionally managed funds. These can track the historical fund’s performance, often in the total market capitalization. With that, gain and loss shares are proportionate to the amount invested by each shareholder.
Bonds
In essence, bonds are investments in the form of loans issued by the government and large corporations to raise funds for expansion or new business operations. These fixed-income instruments are often considered an I.O.U document or contract acknowledging the loan’s existence.
The bond contains all loan and payment details, including the principal amount, maturity date, and interest payments. Usually, bonds are viewed as fixed-income instruments since they earn through fixed interest payments, although variable rates may sometimes apply. Given this, bond prices are inversely correlated with interest rates, making them attractive when the central bank lowers interest rates.
Bonds are excellent choices for risk-averse investors. However, their relatively low returns can make wealth management tedious. On a lighter note, other bonds, such as T-bonds or bills, may have higher-than-typical yields.
Stocks
Stocks, also known as equities, are the most popular on this list due to their vast market coverage. They have been the foundation of investment portfolios for over a century, outperforming other investment types. Also, they give and receive a considerable impact on macroeconomic changes. As such, they must adhere to the Securities and Exchange Commission (SEC).
Stocks correspond to a fraction of the issuing company. Stock units called shares allow investors or shareholders to access the issuing company’s assets and earnings in proportion to their ownership.
Generally, stock price returns are much higher than bonds and mutual funds. But risks are much more evident, given its high sensitivity to inflation. Even so, there are helpful tools and models to assess the stock price.
Fundamental analysis values a stock using company fundamentals, industry analysis, and macroeconomic changes. Meanwhile, technical analysis observes stock price patterns to predict future trends.
Most importantly, stocks have given decent returns over the past decade. Using the Sharpe Ratio, we can weigh returns and volatility. The double-digit average annual returns continue to outweigh the volatility the standard deviation represents.
| S&P 500 (SPX) | NASDAQ Composite (IXIC) | |
| Average Annual Returns | 12.14% | 16.72% |
| Risk-Free Rate | 4.00% | 4.00% |
| Standard Deviation | 17.95% | 20.92% |
| Sharpe Ratio | 0.46 | 0.60 |
Forex
Forex is the most volatile investment on this list. Yet, they are the most liquid and can generate the highest earnings in a single day. Forex trading is done using various currency pairs.
Primary currency pairs like the USD/EUR can have 50-100 pips daily movements. But some pairs, like the USD/JPY, can move at a broader range. So if the USD/EUR moved by 100 pips and a trader has one standard lot or 100,000 currency units, he gains $1,000. If he holds five, he earns $5,000.
In minor pairs, such as GBP/AUD and USD/AUD, the movement can reach 200 pips per day due to higher volatility. Lastly, exotic pairs, such as GBP/MYR and USD/THB, can move by 400 pips.
Real estate
Investing in real estate is enticing due to its appreciation over time. Yet, there are instances when it depleted the wealth of many investors. The Real Estate Bubble is one of the most massive crises the globe has witnessed. It was primarily driven by unethical practices in the market, such as speculative mania and overselling of properties.
Today, the market faces a lower demand due to skyrocketing property prices. Yet, investors must note that it was driven by market forces, such as demand and near-zero interest rates in 2020-2021. Also, the high property shortage can temper the value of a property and slow down price decreases.
Additionally, many investors are drawn to REITs due to their low correlation with stock market volatility. Given their high yields and consistent payouts, REITs can be excellent dividend stocks, making them cheap and attractive.
Key Takeaway
Portfolio management appears challenging at first as it requires investors to select investments consistent with their financial goals. They must assess their risk tolerance and goals and find ways to make prudent investment decisions.
But as they keep doing it, they can maximize returns and minimize risks. To master portfolio diversification, investors may include stocks from various industries and combine them with other investment types.
