In the early 1970s I received my first Lego kit from my aunt and uncle. It was a small kit with few pieces and I played with it for hours. As I grew older my Lego collection expanded to thousands of pieces. A Lego set was my standard gift on special occasions. The nice thing about playing with Legos is the building combinations are limited only by your imagination.
To create a Lego masterpiece, it helps to have bricks of different shapes, sizes and colors. The more pieces you own the more complex your structure can be. Or not. Just because you have thousands of Lego pieces doesn’t mean you have to use them all. A simple Lego structure can work just as well as one with a lot of moving parts, maybe better.
The design of your investment portfolio, similar to your Lego structure, is only limited by your imagination. A well-diversified account is your best bet for long term investment success.
In building your portfolio focus on investments that will zig when the other zags. The best indicator of how two or more investments will perform in your portfolio is the correlation coefficient. Two investments with a correlation of positive one are going to move in the same direction. Investments with a correlation of negative one are going to move in opposite directions. If one is up, the other is down.
Lego sets have changed dramatically from the early 1970s. With my limited choices I could only build so many houses and forts. Lego sets today are mind boggling. A youngster can now build the Eifel Tower, a Ferrari, Jurassic World, and a classic VW Bus. Legos are robots. And movies.
Investments have also changed from the ‘70s. In the ‘70s investments were mostly limited to stocks and bonds. Mutual funds were just starting to gain popularity and Exchange Traded Funds weren’t yet on the horizon. Stock options became available for trading in 1974. Investment fees have changed for the better and to the benefit of the investor. To buy a thousand shares of IBM 45 years ago your commission would’ve cost you thousands of dollars. Today you can buy a thousand shares of IBM without a commission.
Here are a few suggestions for construction your investment portfolio.
- Diversify your investment holdings across asset classes. A portfolio of large, small, U.S., and international stocks mixed in with bonds, real estate, gold, and cash will allow you to participate in most market moves while reducing risk.
- Focus on investments with low or negative correlations. A diversified account will have investments with high and low correlations so make sure they are spread out across different asset classes.
- Keep your fees low. In today’s world you can build a low cost investment portfolio with individual investments or index funds from Vanguard and Dimensional Funds. The lower your fees, the higher your returns. It’s in the math.
- If your happy with your portfolio masterpiece, stop building. A portfolio should be built for the long haul and designed to stand the test of time.
- Review your account occasionally. A quick look and review of your accounts is needed to make sure your investments are performing for your benefit is wise counsel.
Last, be patient when building your investment portfolio. A Lego sculpture of quality takes time and thought but once completed is a thing of beauty. So, too, with your investments!
Therefore everyone who hears these words of mine and puts them into practice is like a wise man who built his house on the rock. ~ Matthew 7:24
Bill Parrott is the President and CEO of Parrott Wealth Management, LLC. www.parrottwealth.com
August 4, 2016