5 essential rules for building a strong core portfolio

There’s a saying that goes “if you fail to plan, you plan to fail”. While that proverb applies to everything, it’s particularly true of investing. Over the next two articles, we’ll look at a series of rules and guidelines you can use to help build a brilliant investing foundation. In this article, we focus on the themes that underline a great core portfolio.

Rule #1: Work out what you want to gain from your investing

It’s great to say you want to make more money but what do you want to work towards? Before you even think of opening an account to start your investing journey, you should have a strong idea about what you want to work towards and how much time you will need (or have) to reach those goals.

Is it travelling the world? Paying down the car? Buying your first home? All the above?

Whatever these goal(s) are, it’s wise to work out what you want, how much you think it will cost, and how long a runway you will have to achieve these goals.

Setting these goals will help you for a few reasons:

• It will force you to think about the medium or long-term goal you have in mind. Thinking long-term helps you ignore the noise, reinforce your strategy and keep you focused on the big picture.
• Setting concrete financial goals will help you work out what your time horizon is as well as the risk profile you have. For instance, if you’ve got a 20-year runway, your risk profile will likely be very different to someone who has five years until their retirement.
• Finally, a longer investment horizon can reduce the risk of loss and give you exposure to most or all of the gains made during your investment journey.

Rule #2: Create a stable and diversified base

Every strong portfolio includes a number of assets that provide exposure to a range of asset classes that will perform well in most market scenarios.

Let’s break this sentence down part by part:

• ‘A number of assets’ does not mean doing the bare minimum. A strong core portfolio doesn’t include just one equities ETF and one fixed income ETF.
• ‘Exposure to a range of asset classes’ means working out each asset class’ strengths and weaknesses.
  • For instance, equities are a great growth asset to have. But when equities have a tough trot, which part of your portfolio will aim to cushion your losses? That’s where an exposure to bonds, cash and commodities may be valuable.
  • A diversified portfolio will also take sectors and even regions into account. Global equities are more than the US stock market and Australian shares are not just the banks and miners.
• ‘Most market scenarios’ implies a range from sizeable downturns to sizeable upswings. Your core portfolio should provide you with decent protection against the first scenario and give you the opportunity to earn some upside in the second scenario.

If you’re a visual learner, it may help to use digital tools (or even a good old-fashioned pen and paper) to work out the asset allocation that is right for you. This will help you work out how much of your portfolio will be core investments and how much of it will be satellite investments.

Rule #3: Work out your core-satellite mix

The weighting in your portfolio for core investments versus satellite investments will be dependent on your time horizon and the amount of risk you’re willing to take^[1].

One general rule is that the longer your time horizon, the more risk you can afford to take by including more growth-oriented assets (e.g. equities) in your portfolio.

For those who prefer percentage guides, one common rule of thumb is the 80-20 rule (sometimes called the Pareto Principle). That is, 80% of your portfolio is in core investments and 20% is in satellite investments^[2].

Other guides present this allocation as a range. For instance, core investments can make up between 65% and 85% of your portfolio while satellite investments make up anywhere between 15% and 35% of the portfolio^[3]. Again, your risk and your time horizon will determine your ideal allocation. If you have any doubt, you should seek personal financial advice.

These guides will also help you work out your allocation within core investments to each individual asset class. For instance, if you are a younger investor with the advantage of a longer time horizon, you may decide that a significant weighting toward equities and thematic investments is for you. Alternatively, if you are an investor focused on keeping a steady income throughout your later life, then your combination may consist of more bonds, income-paying equities and cash than the previous example.

Rule #4: Cheaper is not always better – think differently

The legendary credit investor Howard Marks is known for saying “it’s not what you buy, it’s what you pay”^[4]. Put another way, Marks is challenging us to focus on the value of an investment and not just the price.

Every investment has its price, including ETFs, which have management fees attached to them. Active ETFs typically charge more than passive ETFs and some exposures within each category charge more than others. But be warned – cost is not everything.

In that same vein, the best investors often have views that are independent of the consensus. To quote Marks once again, “If you want to be above average, you have to depart from consensus behaviour.”^[5] Be prepared to read widely, think critically and invest accordingly.

Rule #5: The most important rule – Do your homework

Investing, in many ways, is a second job. Before you invest in anything, you need to make sure you do your homework.

• If you don’t know something, read about it and don’t invest in it until you are sure you understand what you’re getting into.
• Complete a thorough check to make sure what you’re investing in is legitimate.
• And finally, only invest what you can afford to lose.

In part two of this series, we’ll look at three rules to build out your satellite portfolio – or put another way, the spice that makes your total portfolio shine.