Your portfolio should be like marine animal Man O’ War. It should contain different products, all working towards one objective — accumulating enough money to achieve life goals
Your portfolio should be like marine animal Man O’ War. It should contain different products, all working towards one objective — accumulating enough money to achieve life goals
Diversification as a concept is easy to understand but difficult to apply. For many individuals, diversification means holding a number of products and securities in investment portfolio. Here, we discuss why such a portfolio could fail in its objective-to mitigate losses when stock markets tank.
Man O’ War portfolio
You may be aware of Portuguese Man O’ war, a marine animal. This animal is unusual in that it is a colony of genetically-identical animals performing various functions such as feeding and reproduction, but all working together as a single entity. In some ways, your portfolio is like a Man O’ War. It should contain different products, all working towards one objective- accumulating enough money to achieve life goals.
Such a portfolio should protect downside risk yet offer upside potential. The problem is that most investments decline in value during a global crisis. That means diversification through various investments such as equity, bonds and real estate across countries may not be very helpful during a global crisis (example: the 2008 subprime crisis).
This does not mean diversification is meaningless. It does mean that you must use sophisticated models to create a Man O’ War portfolio, not simply invest in different products. The issue is that resources required to create such a portfolio is beyond the scope of most individual investors.
The alternative portfolio is to create a simple portfolio that diversifies the sources of investment returns. Most investments offer two sources of returns — income returns and capital appreciation.
Your portfolio should, therefore, invest in two products- an equity investment to generate capital appreciation and a bond investment to generate income returns, given its finite life. That way, the bond investment can provide stable returns even if the stock market tanks.
The simplest way to create an alternative Man O’ War portfolio is to invest in a bank recurring deposit (RD) with maturity that matches the time horizon for each life goal. Your equity investment could be in a large-cap index ETF or an active fund depending on your risk preferences. Note that an ETF carries only market risk whereas an active fund carries market and active risks. The latter is the risk that the active fund will underperform its benchmark index or generate negative alpha. Both, the RD and the ETF or the active fund can be set up through systematic plans from your monthly income, creating a disciplined approach to savings.
(The author offers training programmes for individuals to manage their personal investments)
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