How is an investment portfolio constructed? Part 2
In the last article I addressed the issue of portfolio management style. Taking advantage of the holiday atmosphere and the food, I made a jocular parallel between how to cook a dessert and a sancocho. The dessert, a delicacy that leaves the cook little latitude for variation and where departing from the strict portions of the ingredients or the baking times, are fatal to the result.
Preparing a sancocho is a different matter, the recipes tend to be multiple as well as the processes and it is possible to vary them and better control the result. A more active and recursive method is required to maximize the result with less risk. A successful investment style is usually less rigid, more interactive and with a good menu of substitutes to achieve a good result.
Having said that, I now want to go back to the basics of formulating and assembling a good investment portfolio. Without good principles and good objectives, there is no cook!
The first step in constructing an investment portfolio is to determine the objective of that portfolio. That is, what does the client seek or expect from accumulating savings? Does the investor want to save resources for his or her old age? Does the client seek capital gains while assuming the risk of losing wealth? Does the client want to leave assets or annuities to his or her children? Each of these questions implies different investment objectives, dealing with different risks and different time frames.
The approach becomes more complicated when the return aspirations and the risks involved in those returns are incorporated. In other words, what returns do I want to achieve, and what and how many risks am I willing to take? Let me explain further. If my goal is to save for old age, I can invest in very safe, low-risk assets. Thus, I will get an accumulation at the end of my life that may not be sufficient for my long old age. Conversely, with the same objective, I may decide to go for an investment portfolio designed to return a better accumulation, but which carries more risk than the safe portfolio. Or if I put myself in the middle, I can divide my savings in the two possible portfolios and thus ensure a minimum and in the other half, I try to compensate, with more risk, what the conservative portfolio does not yield. Clear?
