How to Build a Securities Portfolio: Diversification Strategies
Introduction
Constructing a balanced securities portfolio is fundamental to long-term financial success. Diversification allocates funds across assets that respond to different factors, reducing volatility and minimising losses. This guide covers the principles of diversification, asset allocation strategies, risk management, rebalancing, the use of funds and alternative instruments, as well as operational and behavioural aspects of investing. Practical application examples and case studies will help adapt theory to the real conditions of global markets.
Basics of Diversification
Why Diversify
Diversification is key to reducing systemic risk. If one part of a portfolio incurs losses, other parts may compensate with gains. This principle helps maintain stable returns across various market conditions and accelerates capital recovery after downturns.
Optimal Number of Assets
According to classical portfolio theory, just 15–25 independent instruments can provide 90% of the benefits of diversification. Increasing the number of assets beyond this point tends to reduce return on management fees without significantly enhancing risk protection.
Asset Classes
- Equities: long-term growth, high volatility.
- Bonds: stable coupon income, low volatility.
- Funds: index ETFs and actively managed mutual funds for immediate diversification.
- Alternatives: gold, real estate, cryptocurrencies, art objects serve as hedges against inflation and reduce correlation.
Asset Allocation
Investor Risk Profile
The choice of strategy depends on risk tolerance and investment horizon. Conservatives prefer bonds and fixed-income instruments, aggressive investors opt for equities and alternative assets, while balanced investors select a combination of different classes.
Geography and Countries
Adding foreign assets protects against local risks. For a global portfolio, consider ETFs tracking developed markets (MSCI World), the US (S&P 500), emerging markets (MSCI EM), as well as regional bonds (EM Bonds).
Sectors and Industries
Sectoral diversification includes sectors (IT, biotechnology), cyclical (commodities, industry), and defensive (utilities, food). A balanced selection reduces the impact of industry crises.
The Impact of Macroeconomics
Inflation, interest rates, exchange rates, and fiscal policy all affect asset class returns. For example, rising rates tend to decrease bond prices and may cool the economy, while inflation reduces real returns on cash and fixed coupons.
Risk Management and Correlation
Asset Correlation
Correlation is selected so that assets appreciate at different times. A low correlation (<0.5) allows for a reduction in overall portfolio risk. For instance, gold often rises when equity markets decline.
Value at Risk and Stress Testing
VaR assesses potential losses under normal conditions with a 95–99% confidence level. Stress testing models extreme scenarios: a 30% market crash, liquidity shocks, currency crises, highlighting the portfolio's vulnerabilities.
Hedging
Options and futures allow protection against sharp market movements. Purchasing put options on an index with a loss limitation equates to a premium and helps preserve capital during significant corrections.
Portfolio Rebalancing
Periodic vs Dynamic
Periodic rebalancing is performed regularly (quarterly or annually). Dynamic rebalancing occurs when allocations deviate from targets by a certain threshold (±5%), allowing for quicker responses to market shifts.
Automation
Robo-advisors and specialised platforms (e.g., Portfolio Visualizer) automatically calculate and execute rebalancing, reducing emotional interference and saving time for the investor.
Rebalancing Example
A portfolio has grown to 70/30 in equities/bonds against a target of 60/40. The robo-advisor sells 10% of equities and buys bonds, returning to target proportions without requiring manual intervention.
Funds and ETFs
Index ETFs
ETFs replicate indices such as SPY (S&P 500), VTI (US Total Market), EEM (Emerging Markets). They provide broad market exposure with minimal costs and low spreads.
Active Funds (Mutual Funds)
Mutual funds offer access to niche areas (private credit, infrastructure, ESG), professional management, and the potential for alpha, but require higher fees (1–3%).
Thematic Funds
Thematic ETFs/mutual funds (robotics, green energy, biotech) allow investment in growing sectors. It is essential to assess industry prospects and concentration risks.
Alternative Assets
Real Estate and REITs
Investing through REITs provides rental income (4–6%) and inflation protection. REITs are publicly traded, offering liquidity and dividend payouts.
Gold and Precious Metals
Gold traditionally acts as a hedge against inflation and crises. Gold ETFs (GLD, IAU) simplify access without the need for physical storage and insurance costs.
Cryptocurrencies
High volatility and growth potential make cryptocurrencies a speculative tool. It is advisable to limit their share in a portfolio to 3–5% and utilise stop-losses or options to protect positions.
Operational Aspects
Broker Selection
Key parameters include transaction fees, maintenance fees, availability of margin trading, support for ETFs and derivatives, and the quality of the platform and customer support.
Robo-Advisors
Robo-advisors (Betterment, Wealthfront, Tinkoff Investments) automatically select assets and rebalance portfolios according to risk profiles, reducing time and simplifying the process for beginners.
Tax Optimisation
Utilising investment accounts with benefits (IIS, ISA, 401(k), IRA) lowers tax burdens: dividend deductions, tax exemptions on capital gains for retained assets, and other preferences.
Behavioural Factors and Discipline
Emotions in Investing
Fear and greed can lead to panic selling and buying at peaks. A clear strategy and automation eliminate emotional factors, helping adhere to the plan.
Investment Horizon
Define your goal and timeframe: short-term portfolios favour conservative assets, while long-term investments may weigh more heavily on equities and alternatives to maximise growth.
Dollar-Cost Averaging (DCA) Strategy
Regular equal investments (DCA) regardless of market price reduce the average entry cost and minimise the risk of poor timing.
DCA Case Study
An investor invests 1,000 USD monthly into the S&P 500 ETF from 2010 to 2025, achieving an average purchase price significantly below market peaks and securing long-term returns exceeding 8% per annum.
Conclusion
Diversification is an ongoing process encompassing the allocation of funds among asset classes, managing correlation, rebalancing, incorporating alternatives, and leveraging modern technologies. A balanced portfolio tailored to individual goals and risks can ensure stable growth and capital protection under all market conditions.
Apply the strategies outlined, regularly review your portfolio, and maintain discipline—these are the keys to successful investing.
