How to build a diversified portfolio

Figuring out how to maximise your savings can be a real challenge. There’s no single formula or no one right way to create a diversified portfolio.

But while there are many different paths to financial success, Tony Robbins has categorised into four core principles what he learned from talking with 50 of the world’s top investors.

Think of these four rules as your investment foundation when you’re learning how to diversify.

Use these rules as the basis of your investment strategy, and then select the specific investment opportunity that works best for you.

The four principles:

  • Protect the principal as much as possible
  • Take only asymmetric risks
  • Be tax efficient
  • Be well-diversified

Principle 1: Do NOT lose money

Of course, no one wants to lose money, but how do you do that?

You structure your portfolio so that it can stay above water and minimise your losses, even when the market dips or when you’re wrong.

And you model it on some of the smartest, savviest investors in the world that have proven track records of success. These people are obsessed with not losing money. Completely obsessed.

So how do you not lose money? The secret here is asset allocation.

Think of separating your funds into three distinct investment buckets – the security bucket, the risk/growth bucket and the dream bucket – each with their own levels of risks and rewards.

  • Your security bucket is where you keep funds for things you need, like mortgage payments, insurance and your pension.
  • The risk bucket can be spent on items like real estate, currencies, collectibles and more, items that could have a big reward, but may not pan out. You have to be prepared to lose whatever money you put in the risk bucket in order to receive big rewards.
  • Lastly, the dream bucket. The dream bucket is the place where you can have fun with your money. This is where you can put unexpected bonuses, money for a travel fund and more.

Principle 2: Asymmetric risks and rewards

We have been programmed to think that the only way to grow our wealth involves taking huge risks. That in order to win big, we have to risk losing it all.

But it turns out that top investors follow a different script and take asymmetric risks that are largely based on diversified investments.

Asymmetrical risks and rewards mean that you want to take the least amount of risk possible for the highest level of upside. That’s how you win the game. If you do that, you’ll win long term even if you’re wrong a lot of the time.

One way to bring asymmetric risks and rewards into your investments is to use the 5-to-1 rule.

The strategy here is relatively straightforward. The 5-to-1 rule means that for every dollar you risk, you have the potential to make five.

What this ratio does is allow you to have a hit rate of 20%. You can be wrong four out of five times, but as long as you are right that fifth time, you will break even.

So even if you’re wrong 80% of the time, you can still come out on top. You just have to be right once.

Principle 3: Tax efficiency

When it comes to our investments, we have been taught to focus on returns. But it’s not what you earn that matters, it’s what you keep.

Grappling with taxes might seem harder than creating a diversified portfolio, but if your portfolio isn’t tax efficient, then you may not be keeping as much as you should. In fact, you could be losing money.

While investors in Malaysia are not subject to capital gains taxes, we may be subject to capital gains taxes in the future. Dividends from foreign countries for example, US equities are subject to a 30% tax rate.

Do you have additional questions about taxes or how to diversify your investments?

Consult an advisor or tax specialist to help you better understand all the ways you can maximise the compounding process and create more net growth in your Freedom Fund.

Remember, tax efficiency equals fast financial freedom, and could save you years or even decades of work.

Principle 4: Diversify! Diversify! Diversify!

Knowing where to park your money and how to divide it up is the single most important skill of a successful investor.

Effective diversification not only reduces some of your financial risk, it also offers you the opportunity to maximise your returns. A diversified portfolio is a strong portfolio.

Wait, didn’t we already diversify in Principle 2? Yes! Now it’s time to take it one step further. Now you must diversify within those buckets so that you can structure a diversified portfolio for all seasons.

If you keep all your assets in the same class, you’re not setting yourself up for success. How do you do that?

Here are the four ways you must diversify your portfolio:

  • Diversify between assets within different classes (properties, equities, fixed income, commodities, etc).
  • Diversify your holdings within asset classes (avoid concentrating putting all of your money into one stock or bond; you must diversify even within your asset classes).
  • Diversify globally (different markets, countries, currencies).
  • Diversify timelines (different investment timeframes, maturity date).

By allocating your money to such a diverse range of assets, you will be able to set yourself apart from 99% of all investors. And the best part?

A diversified portfolio won’t cost you a sen because spreading your money across different investments decreases your risk, increases your upside returns over time and does not cost you anything.

This article first appeared in https://mypf.my