The GSE has been poor this year, returning a negative 16.88% as at the end of November 2019 (see full returns here). As a result I have experienced some negative returns in my portfolio this year. Nevertheless, I still have a positive real return for the year because of my exposure to fixed income products.
One would wonder why I do not allocate all my funds to fixed income since stocks are underperforming. That is a bad investment decision usually called performance chasing. I explained why performance chasing is bad for you in another post, so I won’t repeat it here. In this post I want to explain something else – portfolio theory.
Portfolio Theory is present in all introductory finance courses and the concept is simple to understand. Imagine an investor has GHS1,000.00 to invest. Portfolio theory is concerned with how she can allocate the funds among a set of financial instruments such that she will achieve the highest possible return with the least amount of risk.
In practice, this concept comes to life if you look at the returns from all your investments within a particular year and calculate the weighted return instead of just looking at them individually. This allows you to decide whether the combination of all these investments give you a comfortable return at a reasonable level of risk.
I will spare you any mathematical computations as it is not essential to understanding the concept or applying it. What matters is that you be sure that you are truly diversified by examining what makes up your portfolio. Ask yourself the following questions.
- What level of stocks/fixed income/real estate am I comfortable owning?
- What percentage of my portfolio do I want in government securities and what percentage do I want with the private sector?
- How much is my allocation to each investment increasing each month?
- Which one do I fall on first in case of an emergency?
Thinking of your investments as a group is good risk management. Seeking to maximise returns of individual holdings can leave you too exposed to a particular investment which may be hot at the moment. By starting to see your holdings as one portfolio that is supposed to fulfill the objective of maximising returns as well as minimising risk, you can stop being worried about the performance of one particular investment.