Cash, stocks, bonds: How can you choose the right mix of investments?
New to investing? Here's a guide to how much you should set aside with each investment
Dubai: When it comes to dividing your savings among different investments, deciding how much money you should set aside for stocks, bonds, and cash can be a complex decision, for particularly those who are new to investing.
What is commonly referred to as ‘asset allocation’, choosing between each investment, and the respective amounts to be invested in each, largely boils down to how long you expect to stay invested in the asset and how much risk you can tolerate.
“Your target asset allocation should contain a percentage of stocks, bonds, and cash that adds up to 100 per cent,” explained Brody Dunn, an investment manager at a UAE-based asset advisory firm.
“A portfolio with 90 per cent stocks and 10 per cent bonds exposes you to more risk – but potentially gives you the opportunity for more return - than a portfolio with 60 per cent stocks and 40 per cent bonds.”
Your target asset allocation should contain a percentage of stocks, bonds, and cash that adds up to 100 per cent
What should an ideal investment mix look like?
One of the first things you learn as a new investor is to seek the best portfolio mix. Many financial advisors recommend a 60-40 asset allocation between stocks and fixed income to take advantage of growth while keeping up your defences.
The widely recommended general rule of thumb when it comes to asset allocation by age is that you should hold a percentage of stocks that is equal to 100 minus your age.
So if you're 40 years old, you should hold 60 per cent of your portfolio in stocks. Since life expectancy is growing, changing that rule to 110 minus your age or 120 minus your age may be more appropriate.
How do you define your investing objective?
Although choices for investing your savings are continually increasing, every one of those investments can still be categorised as per three integral characteristics: safety, income, and growth, explained Dunn. “Every investor has to pick an appropriate mix of these three factors.
“As an investor, you may have more than one of these objectives, and may well have all three, but the success of one comes at the expense of the others. The first task of any successful individual investor is to find the correct balance among these three worthy goals,” he added. Let's break these objectives down further.
When it comes to safety of an investment, it’s often told that there is no such thing as a completely safe and secure investment, but Dunn noted that investments such as government-issued bonds can be the most safe asset class you can buy into.
Factor in ‘income’, ‘growth’ into an investment?
“If you’re an investor who focusses on income, you may buy fixed-income assets. But your priorities then shift towards looking for assets that guarantee a steady income or a stable source of monthly income. Such income investors may also buy prefer stocks that historically pay good dividends,” he added.
The third fundamental when it comes to choosing your investment is ‘capital growth’, which is achieved only by selling an asset. As stocks are capital assets - barring dividend payments, those who own stocks have to cash them in to realise gains.
While ‘blue-chip stocks’ are generally considered the best among stock investments as many of them offer reasonable safety, modest income from dividends, and potential for capital growth over the long term, ‘growth stocks’ are for those who can tolerate some ups and downs on the stock market.
3 tips to build a diversified portfolio
According to Zubair Shakeel, another UAE-based asset manager, here are the two most important tips for a beginner investor who is seeking to build a diversified investment portfolio.
1. Invest in at least 25 stocks across various sectors
Investing in several stocks is widely recognised as a quicker way to build a diversified portfolio, and a good rule of thumb is to own stocks belonging to at least 25 different companies.
2. Put some of your investments in fixed-income assets
When it comes to diversifying an investment portfolio, another vital step is to invest some of your money in fixed-income assets like bonds, which will lessen the overall risk profile and volatility. However, this move will take a bite out of your portfolio's overall returns.
Final thoughts..
“Building a diversified portfolio can seem like a daunting task since there are so many investment options. A balanced portfolio invests in both stocks and bonds to reduce potential volatility,” added Shakeel.
“An investor seeking a balanced portfolio is comfortable tolerating short-term price fluctuations, is willing to tolerate moderate growth, and has a mid- to long-range investment time horizon, the time period one expects to hold an investment.”
While safety, income, and capital gains should be the key three objectives of a newbie investor, there is one other important factor that is often overlooked - one that should be kept in mind when you choose your investments initially, and that’s liquidity i.e. the 'cash' part of your potential investment mix.
Shakeel explained that investments such as bonds or bond funds are relatively liquid, meaning they can in many cases be converted into cash quickly and with little risk of loss. However, among the above-mentioned three investments, not all of them are as liquid or 'encashable'.
“Stocks are less liquid since they can be sold easily but selling at the wrong time can cause a serious loss. Many other investments are illiquid. For instance, real estate can be an excellent investment unless you are forced to sell them at the wrong time and end up with lesser or even no immediate cash,” he added.