Are you fine with your portfolio?

Looking at the numbers from the market and the economy it looks like we are living strange times indeed, with the major US indices up almost to their tops and at the same time the biggest number of unemployed people in US and pretty dire expectations for Q2 earnings and full year results.
Not much different in Europe.

Should we trust this renewed bull market?
Where will we go from here with the number of Corona cases raising in the US?
Will the power of Fed arsenal be enough to keep the markets up despite the virus, the economy, the protests in the streets and presidential twits?

How much money printing and asset buying by central banks will be done in US and Europe before Corona is over and the presidential elections in US are done?

I do not know! and while it is true that the market can stay irrational longer than you can stay solvent, I argue that in the meantime it is a good time to check that your portfolio is right for your goals, check your diversification and verify that you like what you own.

My goal with this first article is to have you thinking about your portfolio while discussing some basic elements portfolio construction, starting from the basic of “diversification” and main asset classes.

In a further article I would like to write about some hedging strategies, look at a few goals of hedging and then look at a few examples of what to do in specific cases. Just to be ready to act if you start to feel uncomfortable with the market, but you do not want to touch your portfolio.

The master portfolio strategy: diversification

Diversification is THE foundational strategy that anyone should know about and most probably apply in his investments to minimise the most nefarious result of investing gone bad: a severe impairment of your capital.

While some big enough stock going to zero is not so common, think of Hertz these days and you see it is not so remote… and anyway loosing 70, 80, 90 or 95% of your capital is pretty much really bad with respect to your future.

If you loose 70% of your capital, then you would need to have a 233% gain… just to go back to start. Hard? Much better avoid ending up in that situation.
How? Simple enough: avoid putting all your eggs in the same basket or in a few close baskets in the same place. The further apart they are, the less the risk they all get broken or stolen at the same time… 🙂

Diversification 101

Diversification is the process of deploying our investment in different enough products and places so that the risk of them all going against you or being unreachable for you is reduced to a minimum.

What you ideally want is a to pick assets that move as much independently as possible and hopefully do not go down all a the same time… and most probably you would like to have them divided in more than one account, kept in more than one country… ideally. But in practice?

Let’s make a few examples of bad diversification: investing in pretty similar stocks like Facebook, Instagram and Twitter (all social media) or Ford and General Motors (US traditional auto producers); or even buying gold ETF and a gold miners ETF (all following the gold price). These are not well diversified investments as all the picks in each group will most probably go up and down in a similar way.
You would own too much of similar securities, i.e. you would have too much “concentration” on a specific sector. Even if you own an ETF with tens of different companies, but all doing the same “gold mining” work.

Concentration is not bad in itself, it just exposes you to the full consequences of your choices. Very good, very bad or just mediocre… as you make them.
Some of the best portfolio managers run very concentrate portfolios… but they know every tiny detail of what they own and they invest a lot of time and money to monitor that constantly.

If you are not interested in keeping up that sort of monitoring and would prefer a more relaxed approach to investing, then diversification will help you smooth out the edges and take it easier.

Picking randomly a great number of securities is not a great strategy to diversify well either. While it helps to remove the risk of the individual security going bust it might not do much to reduce volatility or drawdowns. Let alone produce good long term results.

As an example one of the most followed and best performing ETF, the “QQQ” -tracking the Nasdaq 100 index-, has about 100 big companies, so it certainly does not risk going to zero, but about 70% of the value is in IT and Telecommunications, so it is not very much diversified in the sector dimension.

The other star ETF “SPY” -tracking the S&P 500 index – is certainly much more diversified, holding about 500 securities and covering all 11 Sectors of US market, but it is far from a suitable diversification as it just covers the stock asset class, mostly of United States companies (about 98%), it is quoted in USD and its sector representation is still pretty skewed, with Technology greater than 25%, Healthcare about 15% and Communications around 10%, while Utilities represent just about 3%.

SPY 5 year chart – Source: Yahoo! Finance –

Looking at the graph of these “SPY” ETFs above it is clear that its performance has been great, but even just in the last 5 years -a period great gains and of economic expansion- there have been some pretty big drawdowns.

Below is the chart for the same period of the iShares 1-3 Year Treasury Bond ETF or “SHY”. The range in the last five years is less than 5%, between 83$ and 86.5 $, way less up and downs than what SPY has sported in the same period, despite unprecedented actions taken by the Federal Reserve because of the Covid 19 pandemic – see the jump from 85$ to 86.5$.

iShares 1-3 Year Treasury Bond ETF (SHY) – Source: Yahoo !Finance –

Would have you slept better in December 2018 by being suddenly loosing 20% or just about 1%? What about March 2020: better be falling more than 30% in less than a couple of weeks or going up 2%?

Of course with the knowledge of after we all prefer being up 50% from 2016 to June 2020, but can you stomach the ride? What if you need some money at the wrong moment: happy to take a permanent 30% cut to your capital?

I have used these two average and pretty common examples of more frequent then you think “uncommon times” to show that different asset classes have different characteristics and are meant to have different roles in a well diversified portfolio. Some pop, some hold.

Diversification tools

Diversification is the mindful act of picking different investments in a way that suits your goals, whatever they are. To reach such a goal it is useful to know the different dimensions that affect your investments and use them as tools to build a portfolio you are comfortable with.

Below is a list of the main diversification dimensions you can use to be on top of your investments:

  • asset classes: stocks, bonds, real estate, gold, commodities, money markets, crypto currencies, volatility based products, …
  • geography: developed markets (US, Europe, …), emerging markets (Brazil, India, Russia…) and frontier markets (al the rest, like Croatia, Lithuania, Kazakhstan, Nigeria, Oman, Romania, … and Vietnam)
  • sector and industry: some sectors are cyclical (they tend to go up and down with the general economy, like travel, luxury and industrials) and some are defensive (they tend to be stable and less dependent on the general economy, like healthcare and utilities)
  • currencies: the currency you use every day and the other main world currencies change their relative values by important amounts, probably by at least 5-10% most years and by over 15-20% every few years; that’s a big tide moving up or down all your investments!
    As an example the EUR/USD exchange rate clearly shows ups and downs all the time. In 2020 we already had a couple of swings greater than 5%.
Source: Board of Governors of the Federal Reserve System (US) –

How to get diversification right?

I showed above that there are many different dimensions to diversification and the examples in the previous sections show that random picking is not the wisest move. So how to chose?

First is to establish the GOALs of your portfolio.
Three typical goals are: capital conservation, steady income and capital growth.
Your choice will have a lot to do with your age, your situation and personality,
but more or less it is a choice along the risk-return continuum:
capital conservation ≈ lower risk <===> capital appreciation ≈ higher risk

Second is to pick a set of investments that fit your goal.
The mix of asset classes is probably the most important driver, with currencies and sectors as other important leverages. Geography is also important, but probable the less so – at least if you mostly invest in more than one developed country.

The “all weather” portfolio

If your goal is on the low risk ≈ capital conservation side and you want to keep it easy, then a good start is Ray Dalio “all weather” portfolio. As the name implies this is a portfolio that is built to perform OK in all market situations and do not let your finance totally stranded by the markets. In any market.
It’s recipe is pretty much simple:

  • 30 % stocks
  • 40% long term (government) bonds
  • 15 % intermediate term (government) bonds
  • 7.5% gold
  • 7.5% commodities

This portfolio has more than half of capital in bonds that should provide slow steady returns and mostly stable prices. The other components of the portfolio have much higher volatility and should provide good returns in different economic situations, with gold and commodities potentially performing better in periods where stocks might not shine much.

If your GOAL is pretty conservative and you are interested in this portfolio a quick search should bring up plenty of results and ways to build it with as low as just one ETF for each component.

One note of caution tough: with the current interest rates close to zero all over the world the high amount of bonds in this portfolio is likely not going to produce much returns. For the long term bonds it is also very well possible that they could lose 10 to 20% of value once the interest rates start to go back to less depressed values: in one year (March 2019-2020) US long term bonds have earned about 40% when rates went from above 2% to almost zero, but they will give back those gains once the rates climb back. Nobody knows when, but in the meantime there is not much possible upside, unless someone expects negative rates also in the US. At the moment I do not.

European and Japan government bonds have very depressed yields since longer and share a similar outlook, so not much happiness in investment grade bonds around the world. This is a real problem, especially for who would just need a decent stable income.

Building your own portfolio

Currently the 20 year government investment grade bonds in EUR or USD yield below 2% in the best cases, while middle term bond yield even less.
The general S&P 500 dividend yield is also below 2% and gold and commodities do not pay any return at all.

If your goal is not to just keep your money safe and barely avoiding to be eaten away by inflation with a portfolio yielding probably less than 2%, you might want to mix and match the different assets to build your own portfolio to fit your goal.

This is no small and easy endeavour, but can bring some satisfaction as well a better sense of control over one’s economic future.
The first step is then to familiarise yourself with the tools available.

Asset classes as main portfolio building tools

So what are the main properties of the different assets?

  • Cash: cash looks like the most stable form of holding your money.
    Stable it is and in turbulent moments -like now- it can offer you the great ability to purchase assets when their price is extremely low. Anyway it is actually quite costly if you factor in the direct cost of loosing value to inflation and the indirect cost of the missed income from different investments.
  • Gold: it is considered a “store of value”, one of the “safe haven” during turbulent times and like cash it produce nothing, but unlike cash gold price can be pretty volatile with changes bigger than 10% almost every year.
    Its function in a portfolio is mostly to keep up with inflation and counter balance more cyclical assets like stocks in turbulent times.
  • Bonds: bonds are debt obligations issued by a government or corporation.
    They offer a huge world and can become pretty complex, so let’s consider fixed interest bonds for sake of simplicity.
    These basic bonds provide you some level on income (based on the annual interest payed by the bond) in exchange for lending your money for some time to the issuer (from a few to very many years). You can sell them before their expiration, but then their price can be up or down from your initial purchase.
    Bonds function in a portfolio is mostly to provide a “ballast” while earning a little of income to beat inflation. They tend to be little to inversely correlated with stocks, so they should keep or raise in value when economy and stocks slow down.
    The main driver for bond prices is government setting interest rates. In slow times governments should lower current interest rates and bonds issued with higher rates should appreciate to align their yield to the new environment.
    • government bonds: these are expected to be the most stable kind of bonds around, but a lot depends on which government issued the bond: US is considered to be the safest, along with Germany and a few others, including some supranational entities (as they are backed by multiple governments). Some are considered on the riskier side of investment grade, like Italy, while other governments are not even considered investment grade.
    • corporate bonds: companies finance themselves by issuing bonds, pretty much like governments, but their size and strength is in general lower than governments, so their bonds are generally considered a bit riskier and thus need to provide a bit more interest than government backed bonds. Nevertheless there are companies that provide pretty safe bonds, while others are not considered investment grade.
  • real estate: it is one of the classical investments and can be performed by buying directly and managing some real world real estate or by using specific financial instruments, like REITS or other RE funds, that give individual investors the ability to access many different real estate sectors (homes, shopping centers, offices, industry, data centers, hospitals, …) in a very liquid way and with the ability to right size the amount to invest in each category.
    The role of RE in a portfolio is to provide an above inflation yield, hopefully smoothing out volatility and with low correlation towards the stock market.
    RE correlation with stock markets change over time, but it looks to be maximum when less desired: in downturns, as stock and RE can both sell off pretty quickly. So RE can offer a diversifying factor, but does not work very well as stock hedge in market stress times.
  • stocks: allow you to become a fractional owner of a company to participate in the growth and success (or fall and tribulations). Stock return come from the eventual dividend payed out from profits and the stock’s price appreciation.
    The role of stocks in a portfolio is to provide superior returns to compensate for their intrinsic higher volatility.
    • individual stocks: stock picking is part art and part science, and the full investment execution, that includes the way and time in and out, is even harder to master than “just” picking good stocks.
      While a great selection can generate superior returns and weather the stormiest markets, without knowing what to do it as much possible to pick dead horses and produce abysmal returns. Individual stock picking also requires a lot of time and effort to study the companies before investing in them and then to keep some monitoring on them.
    • funds: they are investment instruments run by investment managers so that individual investors can just choose between many investment strategies, from the most elaborate to passively tracking an index.
      ETF (Exchange Traded Funds) are funds that trade on an exchange like a company stock, so offer very easy way in and out, while mutual funds are not listed and are valued at the end of the day for inflows and outflows.
      Using ETFs is a simple and cost effective way to invest into stocks with a good level of diversification and the ability to pick the sectors or strategies you feel most comfortable with.
  • commodities: they represent the basic economic materials used in industrial production and cover a wide array of products, from raw materials like ore, metals and oil to agricultural products and live animals.
    It is possible to invest in them directly with futures and ETFs or indirectly (and in a somewhat leveraged way) by buying stocks of their producers.
    Commodities in a portfolio can be used as an hedge, as they are pretty uncorrelated between most of them and with the general stock market. They can also be a speculative investment by themselves, although quite risky as they can experience extreme volatility.
  • volatility based products: this is a category of purely financial products created to allow investors to hedge or even speculate on the market volatility. They are very complex products to master, but with a simple basic way of working: reacting quickly and extremely to big market fluctuations.
    Their role in a retail investor portfolio can be of disaster mitigation.
  • crypto currencies: this is a pretty recent category that covers all the forms of investment in the crypto based currencies, from direct holding in them to options and investment funds.
    They represent an extremely volatile asset, that is not suited for a big part of a portfolio, but a very small investment could provide great returns and work like an hedge towards other assets.
  • alternative investments: under this catch all category we have many types of investments that are not usually part of the core of any retail investor portfolio. They range from the more traditional hedge funds, private equity and special situations funds to the newly created peer to peer lending platforms.
    Again these assets are not suited as main investment, but they can be a diversifying factor inside a well structured portfolio.

Start by picking asset classes

Starting from Ray Dalio “all weather” portfolio with 55% of bonds and 30% stock and 15% between gold and commodities you can tweak first the asset classes and then inside each asset class pick the sector / type that bests suits your goal.

If you want an higher yield you can substitute part of the bonds with large cap, mature stock that provide higher dividend yield than bonds. An easy choice is picking ETFs from sectors with average higher yields like utilities or REITs, or look for ETF specialising in high dividend stocks or dividend aristocrats (increasing their dividend for at least the last 25 years).

They will have higher volatility than the original bonds and will not hold up so well in downturns, but in the long term they should provide better returns than bonds and in the meantime they will bay better than bonds.

So why keeping bonds at all? Well because unexpected thing happen and if you need to raise some unexpected money before you were thinking or inside a big downturn to buy stocks at greatly discounted prices it is useful to have bonds that should not be priced very far from their initial buy price. Bond are still needed to keep the drawdowns in check and to have always some asset that can be liquidated without taking a big capital hit.

How much bonds to replace with stocks and with which kind of stock / REIT it is a matter of preference and goals, or said in other terms it depends on your view of the future and how much risk you are willing to take.

For the stock part it is for you to decide what type of investment looks more in line with your goal. A few common strategies are the following:

  • growth stocks: the idea in this strategy is to identify stocks that are growing quickly and will hopefully grow more than their current valuation multiples.
    They usually do pay little to no dividend as they are investing in growing their operations and gain market share, revenue and hopefully profits.
    Typical examples are biotech and technology companies and you can find stock of any size and in any growth stage. Many ETF focus on this strategy.
  • dividend stocks: this strategy looks for companies with well established operations that pay stable and generous dividends. Generally they are in a mature stage and are often focusing their operations on stable returns to shareholders.
  • dividend growing stocks: this strategy tries to capture the transition from growth to value, i.e. those companies that are still growing (but less quickly) and are starting to pay out dividends and can progressively return more to shareholders over time.
  • value stocks: this strategy looks for companies that offer a good value for your money, i.e. the price looks to be low compared to a (quite subjective) valuation.
    It is a very powerful and proven strategy that has produce some of the best returns and investors of all time, but focusing too much on cheap companies without a proper quality factor incurs the risk of picking up so called “cigar butts”, i.e. company with little to nothing left to give.
    Some companies with valuations that look very cheap compared to past glories but will not recover are also called “value traps”; they often pay a quite lofty dividend until it becomes unsustainable and it needs to be cut or removed altogether.

You can decide to use ETF or funds to gain exposure to the strategies that resonate with you and you can also pick specific stocks that are dear to you, especially if they fit into the strategies you desire.

All these strategies are sound and should work well in your portfolio. The good news is that you do not have to pick one strategy only, you can build the core of your portfolio by investing a percentage of your stock money in a strategy you like and some other part in another. And also slowly change over time.

Just remember one golden rule: investing is not trading.
By this I mean that investing is a long term process where you set some goals and pick some long term strategies to achieve that goals. While you can change strategies and allocations over time, you would do so if you spot an error in your judgement or something disrupting happens.

Trading is instead the fast paced change of position tying to exploit the short term movements of securities and is a totally different matter than investing.
You can even do both if so you wish, but better do not get confused into which is what.

What about gold?
Gold has been raising pretty well in the last year or so (from below 1200$ to above 1700$), but because of the huge amount of new money being printed it is seen keeping its value or even continue its uptrend movement (some predict above 2000$).
If you are worried that inflation will pick up or that the stock market is already too expensive compared to companies results you can get a big more gold than the 7.5% from the all weather portfolio.

And commodities?
The last decade has been a pretty poor one for commodities, with generally negative returns, so why should you buy something that has lost value in the last 10 years? Well for three reasons: the first is the reversion to mean that is quite intrinsic in most financial markets and something can hardly keep just going down forever. The second is that commodities hold up pretty well when inflation heats up as their price increasing are often the very cause of inflation itself. The third is that the many recent years of decreasing prices have limited very much the investments in new capacity, so the amount of commodities available is stable or even decreased and if volume picks up new capacity can not be created overnight, so price will have to rise before new capacity comes to the market. Also producers have become leaner and more efficient, so they will benefit greatly and in a leveraged way from any price increase.

And what about the other asset classes?

All other asset classes are meant to be very small parts of your portfolio and they mostly serve the purpose of diversification or hedging.
They are definitely not meant to represent the core of your investments unless you really know what you are doing and then you already know about all that I am saying.

Putting a few percentage points in these is not going to hurt your main returns, but can provide some welcome surprise. As an example an 1% in some cryptocurrency that some analyst say cold grow 100 times would double your capital if it goes well, leaving with 99% of it in the worst case it goes bust.

Similarly putting a few total percentage points into some higher risk-reward investments like “moonshots” is taking little capital away from your core investments and can “spice up” the total return of your portfolio.

There are a few more topics that I have not even scratched, like currencies and geography, but I feel this can be left to some future discussion.

Put your own ideas and situation in the mix

I have taken you into a quick review of the main assets and strategies I am familiar with and I can not venture further without getting even more in personal territory, while investing it is done for oneself goals, not to follow someone else ideas.

So this is the point where I urge you to take out a piece of paper and jot down your goals, a timeline of them and of your economic needs, try to figure out what yield would bring you there -remember the power of compounding returns- and see what kind of portfolio would do well for you.

It is pretty normal that the goals and the portfolio for someone retired is going to look different from the ones of someone starting a new family into his 30s.
I am halfway there and my situation is certainly different from yours, so what’s good for me might not be good for you, but it could be interesting to discuss about specific ideas.

Writing down this article I have noticed that I am a bit lighter than I want with respect to commodities, so I will take some action on that.

Please let me know by commenting below what do you think and what actions you feel like taking after this reading. Thank you for bearing with me in this initial, long post.

Yours, Roberto


I am not a financial professional, let alone a chartered financial advisor so I can not give you any investment advice. I do not even claim to know all or most of the smart ways to invest, diversify or hedge that have been invented in the Finance industry.
My articles draw from my experiences and readings, exposing to my best the ideas and strategies I became familiar with as a self taught investor and hoping to start a discussion around them with the goal to improve all participants.
While I am making all efforts to be accurate and correct, I cannot guarantee the absence of errors or of providing a correct representation of the concepts presented. You are responsible of making your own investing decision.