Optimal Portfolio Allocations

Hi all,

I’m a relatively new user of this platform but have been interested in markets and investing for a long time. However, I get this feeling that my portfolio isn’t allocated efficiently.

When I opened my account I purchased shares in companies that I thought or had read that would be good picks for the next year. I accept that I have to hold my investments for a long time to see returns but I get this feeling that my portfolio allocation isn’t efficient. It’s not diversified enough both in companies and sectors.

I know part of this problem is both poor initial investing and a lack of funds to buy a wide enough range of positions. Has anyone else felt this before and if so what did you do to resolve this?

I’m hoping fractional shares will help me overcome this issue in the weeks to come.

Hi Matt,

Welcome aboard :wave:

I felt the same at the turn of the year. I was no longer confident in some of my picks and was over exposed to a couple of markets.

I wrote a little about it in this thread:

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The initial problem is that you assume you can outperform the market by stock-picking. This is a fallacy. You should invest most of your funds in Etfs which automatically diversify against unsystematic risk.

And believe nobody when they give you stock recommendations. Not many really know what they’re talking about.

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I agree and I have more money elsewhere in ETFs and in my FT portfolio. But the problem I have is that until I can buy fractionally into an ETF I can’t afford to allocate my funds there at the moment.

Good advice, I’m up a few % on it right now so maybe I’ll hold for a little longer :man_shrugging:

I remember reading this, thought it was really intresting and an approach I may look to copy in the future.

Msci world (IWDG) on Freetrade is 5 quid.

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I read an intersting investing book last week. It’s a bit outdated (2013 IIR) but the crux of the book is that you will never beat the market so don’t try.
It also has some interesting bits about building a strong portfolio by mixing low risk with high risk.

Worth a read - Smarter Investing

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Thought I’d share this tidbit that I got through work from a big bank management sector of their business

Edit too stupid to block out the name please @anon810895 can you block the name buddy. Forgive me its my birthday and I’m out for a few brews

Portfolio allocation ultimately is about diversification, which is about risk appetite. There are many lenses that you should consider allocation through:

  • Am I diversified enough across industries?
  • Am I diversified enough across small/mid/large cap?
  • Am I diversified enough across geographies?

In its strictest form, however, allocation is the choice between different types of asset classes. Modern asset management began in the 1950’s with the Modern Portfolio Theory and the Capital Asset Pricing Model which, when combined, found an “efficient frontier” whereby the mix of 60% equity and 40% bonds provided the optimal mix of risk vs return, providing on average a return of c10% per annum.

This 60/40 model was so successful, it became know in the industry as “set it and forget it” and was the dominant model for 50 odd years. The dot.com bubble changed this, resulting into three strategies to boost returns, but with less risk and at lower cost.

  1. Investors sought to reduce the fees they paid by seeking out lower-cost approaches to obtain their equity market exposure. This gave rise to the ongoing shift from active management towards passive, and resulted in the popularity of indices and ETFs.

  2. Institutional investors shifted assets from high-risk equity strategies to strategies that offered equity like returns at bond-like risk profiles. This gave rise to hedge funds.

  3. They sought to take advantage of longer-term investment horizon to seek illiquid assets that could offer uncorrelated return streams to their portfolios, things like property, private equity, venture capital funds, SME loans, etc.

All this led to the gradual breakdown of the 60/40 model, accelerated by the Yale “endowment model”, which invested more heavily into alternative asset classes.

It all led to a shift in AUM allocation, with in 1997 60% equity, 35% bonds and 5% alternatives, to a 2016 split of 48/28/24%

Therefore, you can take as a starting point this split for your own portfolio, ensuring that you have a similar coverage over equity, bonds and alternatives. From there, you adjust according to your own risk appetite.

You can try to get the optimal allocation across equity by picking a meaningful number of stocks. In 1970, Lawrence Fisher and James H. Lorie released "Some Studies of Variability of Returns on Investments In Common Stocks“ published in The Journal Of Business on the “reduction of return scattering” as a result of the number of stocks in a portfolio. They found that a randomly created portfolio of 32 stocks could reduce the distribution by 95%, compared to a portfolio of the entire New York Stock universe.

The question that then arises is whether you are comfortable to pick a minimum of 30 stocks and keep an eye on them. Warren Buffet argues to “Consistently buy an S&P 500 low-cost index fund," as one of the best ways to grow wealth. “I think it’s the thing that makes the most sense practically all of the time.”, he said. I am of a similar opinion, most people won’t outperform the stock market themselves, and it’s best to put a high % into a low cost ETF.

Bonds are much easier to juggle yourself, you just pick them across sufficient geographies and you should be covered. Alternative asset classes are more difficult to get by. Private equity typically isn’t available to private investors and startups are not yet listed on the stock market. Your best bet is to get REITs and invest through those in property. Crowdfunding is another option to access alternatives, and although the tax benefits are attractive through SEIS and EIS, failure rates are high.

Therefore, to cut a long story short, theory has it you should have 48% equity, but wisdom then tells you to invest the vast majority of that in ETFs or other passive, whilst you also hold 28% bonds (government most likely) and the remaining 24% in alternatives (property in the absence of much other options for alternative to retail investors).

Personally I’m a happy go lucky, FOMO YOLO kind of guy and throw caution to the wind as my risk appetite is high with regards to FreeTrade as it’s money I can afford to lose. My portfolio on FreeTrade is pure equity, although 70% ETFs, with the rest in individual stocks.

However, this is balanced off by my other investments. I have a sizeable crowdfunding portfolio, but also churn the majority of investments into more traditional vehicles like a company pension, an offshore private pension and an offshore trust fund. These balance out my risky approach on FreeTrade.

Edit: maths were failing me somewhat, thanks to Raul for pointing out. Now off to get more coffee. :joy:

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Another great post @Marsares :+1:

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Some good suggestions here. It’s really each to their own.

I’m derisking my portfolio now - selling at a profit and moving 50-60% of my portfolio into Gilts and 7-10 year US Treasury notes. While at the same time with 10-15% of my portfolio making a number of small bets - mainly in biotech with the hope that one or two hit big.

Very interesting post above @Marsares thanks - would you be able to point the non-expert reader at anything that unpacks this a bit more? I ask because most of what I’ve read about asset allocation seems to still take 60/40 (or variants, 80/20 and so on) as foundational.

60% equity / 40% bond is still the norm for the retail investor, partially because its been the norm for so long and advisors and retail investors themselves have grown up with this as it has stood the test of time.

But also perhaps because alternatives are much more difficult to access for retail investors than it is for institutional ones. Institutions typically lead the way though, and in years to come I suspect alternatives will become much easier accessible and portfolio allocations for retail investors will shift as a result.

There’s an “all weather” portfolio by Ray Dalio, which he revealed in Tony Robbins’ Money book. I don’t follow the strategy though (yet) but it appears that he may have been “right” more often than “wrong” as he’s consistently delivered returns over the years - especially in times like today:

CNBC:

A typical portfolio might be split between 50 percent bonds and 50 percent stocks, but Dalio argues that isn’t really diversified in “Money: Master the Game” by Tony Robbins.

“When you look at most portfolios, they have a very strong bias to do well in good times and bad in bad times,” Dalio says in the book. To avoid your portfolio simply rising and falling with the market, his advice is to spread out and balance the risks of each investment.

Here’s his breakdown for what a well-diversified portfolio might look like, according to the book: 30 percent allocated to stocks, 40 percent to long-term U.S. bonds, 15 percent to intermediate U.S. bonds, 7.5 percent to gold and 7.5 percent to other commodities. (The portfolio does need to be rebalanced annually, he adds.)

This comes from:

He’s got access to to the bond and commodities markets while retail investors may have to use proxies, that follow them closely. Not sure here.

This is not an investment advice.

This is a book reading advice. That book where the portfolio was revealed is one of the best investments and it costs less than £10. It’s a long read though. The guy interviewed billionaire investors because he himself is a billionaire and is good friends with some of them. He coaches some of them. The 2008 crisis and the aftermath were some of the reasons why he wrote the book for the masses.

Thank you all for the above recommendations, I’m much happier with where things are at right now with my portfolio.