How to Develop a Truly Well-Balanced Portfolio: The Biggest Misconception of Young Investors

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Hello All!

Let’s go over the truth about developing a well-balanced portfolio and what exactly defines a “risky” or “secure” investment.

Analyzing your risk tolerance is a critical concept to consider when establishing your portfolio. Without special care, your investments can become extremely volatile.

Today I want to help you realize your risk tolerance and be able to construct a deeper understanding of how to create a REAL well-balanced portfolio.

A TRULY balanced portfolio

We’ve all heard it before. You MUST have a well-balanced portfolio. What they don’t tell you however is what exactly ENTAILS a balanced portfolio.

When we hear “balanced portfolio” we think 50% of investments contributed towards risk and 50% of investments towards security. Believe me I thought the same thing.

HOWEVER,

A 50/50 portfolio isn’t really balanced.

How you ask? Think hard, if we have half of our assets in risky investments, were really not perfectly balanced. In reality, because of the sheer volatility of those riskier investments in relation to those which are more secure, a 50/50 portfolio diversification is more so like a 70/30 split!

It is our job as investors and controllers of our money to be well-balanced and be able to better sustain our growth rates without experiencing large downturns.

Let’s piece this together.

Your Risk Bucket

Here’s were the fun comes into play. Your “Risk Bucket” is meant for all of those stock, real estate, and business investments that keep life interesting. This is by far the best place where you will see the most growth in your portfolio, so naturally your risk bucket is what we keep most of our attention on.

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Everything in this bucket is extremely versatile. Nothing within this part of your portfolio is guaranteed, instead it is inherently more riskier hence the name.

Any investment that can experience large amounts of volatility and isn’t backed by fixed interest rates or definitive numbers can be classified as a risky asset that would be placed within here.

These include…

  • Stocks
  • Commodities
  • Real Estate
  • Business Investments
  • Collectables

Although these types of investments can be extremely volatile, risk can be managed. Picking specific stocks, for example, Index funds, with great long term growth can be a way to manage said risk. Another example would include not overpaying for a home by understanding the cost of maintenance and appreciation of value over time.

A good question to ask yourself when making an investment like this would be, “Can I be sure that I can minimize the risk of this investment.” Investors are OBSESSED with minimizing risk on their investments because they realize that although you can make a lot of money in this portion we can also lose a lot of money. We love to see when the prices are green and were making money but we underestimate our strength to watch all of those earnings go down the drain. Remember, it takes more to increase investment value than it does to decrease. So handle this portion of your portfolio with care, and make sure not to bet everything on red.

Now here comes the trap. Allowing your risk bucket to be your ONLY bucket.

Your Security Bucket

By far one of the most underrated and misunderstood portions of a well-balanced portfolio is your security bucket. Most people aren’t talking about this because it isn’t per say “sexy”. As human beings our emotions draw us towards excitement. We become obsessed with fantasizing about giant returns and the rewards that come along with it.

What we don’t fantasize about are those giant amounts of risk that we take on when our security buckets are dry.

So what exactly can be define as a “secure” investment?

Examples of secure investments include…

  • TIPS
  • Government Bonds
  • FIAs (Fixed Index Annuities)
  • Corporate Bonds
    • These can be risky at times so make sure to look at the corporates ability to manage its assets and debt as well as their bond ranking before making this type of an investment

Yes I know, none of these are the most “sexy” thing in the world but do you know what’s not sexy? Losing all those oh so sweet returns that compiled within your risk bucket during the upturn of the market and then when the inevitable downturn comes all of your earnings fall out from under you.

What’s Your Risk Tolerance?

My goal here is to help you as a conqueror of your money to be real with yourself in order to develop the risk tolerance that is manageable and realistic.

Trust me, when I first started investing, I was as risky as any young investor could be. Pouring all of my money into one area thinking I was diversifying but in reality I was just setting myself up for an enormous downfall (which inevitably wasn’t pretty).

Don’t do what I did and underestimate the power of your security bucket. Think what a realistic percentage of diversification would be for you! Because I am younger and have more time for error, I have gone with a 40% risk and 60% secure allocation, which is still really a slightly more risky allocation as I have explained earlier.

As always thanks for your input, any type of feedback is much appreciated as it helps me develop better information and content for you as a reader! Also don’t forget to sign up for the email news letter to be notified when more helpful tips and tricks are released!

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Andrew Martinez, owner and writer of Minerva Money

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Published by Andrew Martinez

Owner and writer of Minerva Money, a blog on personal finance for the average person who is interested in taking control of their future and alleviating themselves from the burden of uncertainty. I have a deep passion for helping those around me with not only finance but mental well-being so if you have any questions or just want to talk don't hesitate to reach out!

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