People do the darndest things. For example, they put their investments in places where they don’t belong.
This is a common problem suffered not just by retail investors, but by experienced professionals who are hired to advise them. In each case, there’s a poor understanding about the basic elements of a well-built portfolio. (In extreme cases, there may be knowledge of these basic elements, but an undisciplined framework or a perverted investment philosophy that prevents proper execution.)
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The figure below illustrates the three key elements of an architecturally sound portfolio: An investment portfolio’s core, it’s non-core, and its margin of safety. Together, these three distinct mini-portfolios are the framework for a person’s total portfolio.
Did you notice how each of these three separate portfolio parts deliberately owns non-overlapping assets? Did you also notice how the core portfolio is the largest circle or largest part of a person’s total portfolio?
When a non-core asset like an individual stock, currency, or collectible is or is permitted to become the largest asset within a person’s investment portfolio, do you know what happens? They’ve misplaced that asset by putting into a place where it shouldn’t be; inside their core portfolio.
The core part of a person’s portfolio is always the largest part of these mini-portfolios and is divided across the five major asset classes: stocks (NYSEARCA:SPY), bonds (NYSEARCA:BOND), real estate (NYSEARCA:ICF), commodities (NYSEARCA:GSG), and cash (Nasdaq:SWMXX).
Finally, the investment vehicles used to track these five core asset classes should be accurate proxies of the asset classes where they invest, broadly diversified, tax-efficient, and low cost.
Ron DeLegge is the Founder and Chief Portfolio Strategist at ETFguide. He’s personally analyzed and graded more than $100 million in investment portfolios using his Portfolio Report Card grading system which helps people to identify the strengths and weaknesses of their IRA, Roth IRA, and 401(k) plan investments.