When we start investing we buy things — promising ETFs, shiny stocks, local and offshore — and we have fun with the buying process without totally focusing on the bigger picture.
After a while we look at our portfolio and it’s a collection of, well, various different investments. There’s a particular reason we bought each of these, but the overall portfolio lacks any coherent strategy. This is what I want to focus on: portfolio construction.
First, let me say there is a ton of research and academic theories on what the perfect portfolio should look like, but that’s generally deep maths and isn’t useful for us as individual investors.
Rather start by imagining your portfolio like a pyramid, with your low-risk investments at the base and the high-risk ones at the pointy top. Naturally this low-risk base should be way larger in rand terms than the top, and that’s where I put my ETFs. Your ETF portion should be at least 50%, but there’s nothing wrong with having that number much higher, even 100% works perfectly fine if you want to keep it really simple. You’d include cash and bonds here, as they really are low-risk.
Next up on the pyramid would be those high-quality stocks you’d ideally hold for the very long term, collecting dividends and capital appreciation.
The next level is what I call my second-tier portfolio. These are stocks I hold but that I fully expect to sell in time, usually after a couple of years. Here I have small caps with potential, cyclical stocks such as miners and my more speculative holdings.
Right at the pointy end would be your trading, derivatives and crypto.
The percentage split between the levels is up to you, but with the weighting decreasing as you move up the pyramid.
The other big question is: how many individual stocks? I typically hold about 15, which is considered concentrated. But that concentration is offset by the large base of ETFs that will be literally thousands of shares.
With this structure in place you need to check the actual holding. Do you have four gold miners? In that case you’re not diversified, you’re a hardened gold bull — which is fine, but understand and be comfortable with that concentration risk.
I also always ask why I own a stock. Not why I bought it, but why I still hold it. Is there a compelling reason? Is there perhaps a better alternative? Or maybe my initial investment thesis has simply not worked out. In which case I’d be better off using the money elsewhere.
I am always looking to get rid of the dregs and the really small positions. If a holding is less than 2.5% it’s never going to move the needle, so I either need to increase the holding size, or exit it completely.
Again, this is not a perfect science, but over time we get better and smarter at managing the process.
Would you like to comment on this article?
Sign up (it's quick and free) or sign in now.
Please read our Comment Policy before commenting.