Dubai: When it comes to dividing your savings into different investments, deciding how much money you should allocate to stocks, bonds and cash can be a complicated decision, especially for those who are new to investing.
Commonly referred to as ‘asset allocation’, choosing between each investment and the respective amount to invest in each largely boils down to how long you expect to stay invested in the asset and how much risk you can tolerate.
“Your target asset allocation should include a percentage of stocks, bonds, and cash that add up to 100 percent,” said Brodie Dunn, investment manager at a UAE-based wealth advisory firm.
“A portfolio with 90 percent stocks and 10 percent bonds exposes you to more risk—but potentially gives you a higher return opportunity—than a portfolio with 60 percent stocks and 40 percent bonds.”
Your target asset allocation should include a percentage of stocks, bonds, and cash that add up to 100 percent.
– Brodie Dunn
What should an ideal investment mix be?
One of the first things you learn as a new investor is finding the perfect portfolio mix. Many financial advisors recommend a 60-40 asset allocation between stocks and fixed income to take advantage of growth while maintaining your safety.
A widely recommended rule of thumb regarding asset allocation by age is that you should hold a percentage of stocks equal to your age minus 100.
So if you’re 40, you should keep 60 percent of your portfolio in stocks. As life expectancy increases, it may be more appropriate to rule out 110 minus your age or 120 minus your age.
How do you define your investment objective?
Although the options for investing your savings are constantly expanding, each of those investments can still be categorized according to three integral characteristics: safety, income and growth, Dunn explained. “Each investor should choose the right mix of these three factors.
“As an investor, you can have more than one of these objectives, and all three, but the success of one comes at the expense of the others. The first task of any successful individual investor is to find the right balance between these three worthy goals,” he added. Let’s break the objectives down further.
When it comes to investment safety, it is often said that there is no such thing as a completely safe and secure investment, but Dunn noted that investments such as government-issued bonds may be the safest asset class you can buy.
Factor in ‘income’, ‘growth’ in investment?
“If you’re an investor who focuses on income, you can buy fixed-income assets. But your priorities shift toward looking for assets that guarantee steady income or a stable source of monthly income. Such income investors can also buy stocks that have historically given good dividends, ” he added.
What is Fixed Income Assets?
Fixed income investments are low risk assets that provide returns through fixed periodic interest payments and final return of the initial amount at maturity. A good example apart from bonds is Fixed Deposits or FDs.
The third fundamental when it comes to choosing your investment is ‘capital growth’, which is achieved only by selling the property. Because stocks are capital assets—except for dividend payments, those who own stocks must keep them in cash to reap the benefits.
While ‘blue-chip stocks’ are generally considered the best of stock investments as many of them offer reasonable security, modest income from dividends and potential for capital growth over the long term, ‘growth stocks’ are for those who can tolerate some downside. and stock market declines.
Glossary: ’blue-chip stocks’, ‘growth stocks’
A ‘blue-chip stock’ is a company that usually has a large market cap, an excellent reputation and many years of success in the business world. On the other hand, ‘growth stocks’ are companies that are expected to grow sales and earnings at a faster rate than the market average. Technically, growth stocks are defined as those with a 5-year average sales growth above 15 percent.
3 tips for building a diversified portfolio
According to Zubair Shakeel, another asset manager in the UAE, here are two important tips for beginner investors looking to build a diversified investment portfolio.
1. Invest in at least 25 stocks in different sectors
Investing in multiple stocks is widely recognized as a quick way to build a diversified portfolio, and a good rule of thumb is to own stocks belonging to at least 25 different companies.
2. Keep some of your investments in fixed income assets
When it comes to diversifying an investment portfolio, another important step is to invest in fixed-income assets such as bonds, which will reduce overall risk profile and volatility. However, this move will take a bit from your portfolio’s overall return.
“Building a diversified portfolio can seem like a daunting task as there are many investment options. A balanced portfolio invests in both stocks and bonds to reduce potential volatility,” added Shakeel.
“An investor seeking a balanced portfolio is comfortable tolerating short-term price fluctuations, willing to tolerate moderate growth, and has a mid- to long-term investment time horizon, which is the time period expected to be invested.”
While safety, income and capital gains should be the main three objectives of a new investor, there is one more important factor that is often overlooked – that you should take into account when you are initially choosing your investments, and that is liquidity. The cash portion of your potential investment mix.
Shakeel said investments like bonds or bond funds are relatively liquid, meaning they can be converted into cash quickly in many cases and have little risk of loss. However, out of the three investments mentioned above, not all of them are liquid or ‘disposable’.
“Stocks are less liquid because they can be sold easily but selling at the wrong time can lead to serious losses. Many other investments are liquid. For example, real estate can be a great investment as long as you are not forced to sell them at the wrong time and end up with little or no immediate cash,” he added.