Creating a balanced portfolio is a lot like making a perfect and personal salsa. Dr. Craig Israelsen, professor and author of 7Twelve: A Diversified Investment Portfolio with a Plan says there are a few rules that apply even to this most free-form of dishes.
To start, it’s important to understand the ingredients and the roles each one plays in your salsa. Then you need to decide the proportions of the ingredients and also understand the ultimate taste you are driving toward – in short, where your salsa will fit in your meal, or how your investment strategy will serve your life. Here are a few key rules:
- While tomato and onion alone won’t make a balanced salsa, too many ingredients will ruin a good salsa. In investment terms, I often see portfolios packed with dozens of mutual funds and exchange-traded funds (ETFs) of all varieties, and yet I find that all own the same stocks. We want the right balance of the right kinds of investments, rather than the “everything but the kitchen sink” approach.
- Certain ingredients have no place in a salsa. The investment approach I recommend generally avoids “junk bonds” and instead focuses on stocks for the ‘spice’. We use high-quality, safe bonds to balance out the risk in stocks since having too much risk in both bonds and stocks can make the mix hotter than we can handle! By having ingredients with complementary characteristics, you don’t experience the extremes, and can end with a more purposeful outcome that takes advantage of investments that will react differently in different markets.
- While comparing performance of your investments to the S&P 500 or another market benchmark may seem like a good idea, it can be as fruitless as comparing a tomato to a salsa. Diversification means that the many parts of our salsa will provide different results. It isn’t worthwhile to constantly compare a salsa (a balanced portfolio) to a tomato (US large company stocks). Rather, the more important questions should be how much of the portfolio in US large company stocks we should include in our mix to meet your objectives, and do we have the highest quality fund for that part of the recipe.
A good salsa has a mix of ingredients, some sweet, some spicy, but each meant to play a role and to provide a mixture that provides something more than the ingredients alone. Before you can put together a salsa, you need to know a little about the ingredients and how they interact. Here are the roles of investment ingredients that investors should target:
- Growth. Over time horizons of ten years or more, a broad mix of stocks has historically provided returns that beat inflation and more stable investments.
- Stability. Safe and stable, plain vanilla bonds, CDs, and other fixed and high-quality investments provide an important base to any investment plan.
- Alternatives. I think of real estate, precious metals, and other non-traditional stock and bond investments that do not traditionally track market returns as ‘inflation-hedges’ and ‘real assets,’ because they can complement our stocks, bonds, and pensions by their returns zigging when traditional financial assets may zag.
After the ingredients are selected, there is a much more meaningful question still to answer – What is the appropriate mix for your investment portfolio? My personal philosophy involves low-cost ingredients that include healthy amounts of stocks, bonds, and alternatives in a steady mix.
However, this is the part where the meal begins to become personal. We all have our own needs, preferences, and circumstances unique to our lives that call for a personalized plan. When making your investment salsa, it becomes about much more than the individual parts, or who will do the mixing.
When will you need to tap into your portfolio?
Do you have a pension or other income streams or resources outside of your investment mix?
How will taxes play a role in your plans – today and in retirement?
What I think I like the most about the salsa analogy is that it starts and ends with realizing that investing isn’t about a cookie-cutter approach to buying and holding funds, but it is much deeper and more personal. Most will find that parts of the above require a professional chef that knows your tastes and objectives. A CERTIFIED FINANCIAL PLANNER™ professional often does much more than that by being able to advise not only on what investments to buy and how to mix them, but how they fit in with your insurance, retirement, tax and estate strategies.
As I frequently find when I try to ‘play chef’ in my own kitchen, sometimes it is better to work with a professional, than to experiment outside of your comfort area! If you have wondered if your portfolio is in balance with your needs, find a CFP® professional here.