Portfolio Construction
A home and investment portfolio are two of the most important family assets. There are also many similarities between a well-constructed portfolio and a well-constructed home. Both are built on solid foundations guided by time-tested fundamental principles. In addition, they both feature characteristics that are tailored to the owner’s specific needs and desires. This report reviews the fundamental guiding principles of a well-constructed portfolio.
PART 1
THE FUNDAMENTALS
Similar to a home, the foundation of a portfolio is critical. Prudent portfolio management is based on three, long-standing, fundamental investment principles.
- Asset allocation—the strategic blend of asset classes such as stocks, bonds, and cash—is dictated by a client’s specific investment objectives and risk tolerance. Market timing strategies do not play a significant role in determining a client’s asset allocation.
- Diversification is regarded as the primary tool for reducing risk. A properly diversified portfolio will limit risk without sacrificing return potential.
- Security selection is based on a fundamental understanding of the risk and potential reward of each investment, viewed with a long-term perspective, within the context of a client’s overall portfolio structure.
A well-constructed portfolio begins with a diverse mix of high-quality stocks and bonds, and cash. High-quality stocks have a history of outperforming most other assets and are critical for maintaining an investor’s purchasing power over the long run. Investment-grade (high-quality) bonds offer current income and diversification, which helps reduce portfolio volatility (described later in this report). Cash is important for unexpected “rainy day” expenses, provides income and diversification, and can be used to take advantage of timely investment opportunities.
