One of the most fundamental issues for investors is how to create a properly diversified portfolio – whether from scratch or by reworking an existing portfolio.
When creating their portfolios, investors should consider such issues as their investment objectives, their investment time horizon, risk tolerance, tax implications, investment costs and their behavioural traits as investors.
A recent research paper, Vanguard’s approach for constructing Australian Diversified Funds, has distilled these considerations into four key investing principles:
- Goals: Investors should have clearly-stated and appropriate long-term goals for their investments.
- Balance: Their asset allocation should be balanced in its exposure to the various asset classes appropriate for reaching these goals. And periodic rebalancing back to their target long-term asset allocation is critical. (With a professionally-managed diversified fund, the portfolio is monitored and adjusted with a regularity beyond the scope of most individual investors.)
- Cost: Minimum investment costs increase the changes of long-term investment success.
- Discipline: Investors who maintain a discipline, long-term and non-emotional approach to investing, without being swayed by short-term market movements and "noise" have the best chance of investment success.
Vanguard addresses these four principles when designing its diversified funds, including its diversified index exchange traded funds (ETFs). And these principles are, of course, also critical to individual investors who create portfolios without investing in diversified investment funds.
"To the detriment of their portfolio and performance," the research paper concludes, "too many investors focus on the markets, the economy, individual manager performance, or the performance of an individual security or strategy, instead of focussing their efforts on the core fundamentals of balanced asset allocations and a long-term investment perspective."