The Science and Art of Successful Investment Portfolio Construction

Successful construction of an investment portfolio for the long term requires full measures of science and of art. The late David Swensen, chief investment officer of the extraordinarily successful Yale Endowment, gives insight on how to achieve this in his book Unconventional Success: A Fundamental Approach to Personal Investment. If investing in risk assets like equities, the time horizon over which the investor wishes to invest is crucial. If wishing to protect existing capital or grow capital by investing in risk assets, the investor must be comfortable holding investments for a minimum of 7 to 10 years. This assumes that the investor has made provision for income from other sources. There is nothing more damaging to an investment strategy than selling securities to raise capital at the wrong time. If done regularly, this will render the strategy impotent and produce poor investment results.

Common-sense incorporation of individual characteristics into the allocation of assets is key to constructing an investment portfolio. Devoting significant time and knowledge to the science and art in designing long-term portfolios increases the likelihood that investors will maintain a steady course amid the turbulent crosscurrents’ endemic to security markets.

Diversification provides the only free lunch to the hungry investor, helping produce risk adjusted returns, and a bias towards the risk asset of equities promises the possibility of greater wealth accumulation. However, you can overdiversify.

Individual personal preferences play a critical subjective role in a portfolio decision, and if an investor does not wholeheartedly embrace a particular portfolio structure, failure is guaranteed. Positions held with little conviction invite casual reversal, exposing vacillating investors to the costly consequences of being whipsawed by the market. By adopting asset allocation targets, investors vastly increase the odds of investment success.

Individual circumstances introduce important considerations to the structuring of a portfolio. Non-financial assets so often ignored by investment managers, such as homes, mortgages, and personal loans, should be considered when making asset allocation decisions. The time horizon over which the investor is comfortable committing capital into the market is one of the most important variables to achieve successful outcomes. Investors who need funds to satisfy short-term obligations require certainty of value and immediacy of liquidity, causing them to choose high quality money market funds. Investors who hold funds beyond the short term can embrace the opportunity to accept price volatility and increased return from risk assets such as equities. The heart of the investment process lies in producing a coherent set of portfolio targets that reflect the science of applying fundamental investment principles whilst incorporating the art of meeting investor needs and preferences.  Thoughtfully constructed and individually chosen allocation targets provide the strongest foundation upon which to build a successful investment programme. How is your portfolio structured?

Jeremy Blatch TEP
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