ArtsAutosBooksBusinessEducationEntertainmentFamilyFashionFoodGamesGenderHealthHolidaysHomeHubPagesPersonal FinancePetsPoliticsReligionSportsTechnologyTravel

Make Money In Any Market: Balance Your Portfolio

Updated on December 10, 2014

Mix Your Investment Assets to Reduce Risk

What is a "balanced" portfolio?

Why should mixing different asset classes make your investment portfolio much less risky?

Here is an explanation (and some of the maths) behind this useful risk reduction method. Most portfolios are highly correlated to just the stock, bond or property markets and when disaster strikes all of these markets can fall. Having a mixture of these different investments and other uncorrelated assets such as precious metals however can provide some insurance against this outcome.

Gold and silver are volatile and have had a bad time against the dollar recently (although have performed well when compared with pounds Sterling) but are generally uncorrelated to other assets so they can be used to reduce your risk. Throughout history Gold and Silver have been real money. The dollar, pound, euro and yen are just pieces of paper ("fiat" money) and have no actual value. If the dollar or any other major currency collapses gold and silver should retain their value.

Stock markets are high-risk, but can give very good returns or lose you all of your money, whereas bonds are mostly lower risk and generally not very correlated to stocks and do pay an income, but are far less fun and gold pays no income, but does at least preserve some of your wealth when disaster strikes. A balance between these asset classes and property is usually the best bet. To find out why read on...

Disclaimer: Information in this and other linked articles is unregulated and for general information only and is not intended to be relied upon in making specific investment decisions. Appropriate independent advice should be obtained before making any such decision.

Don't put all your eggs in one basket

Disclaimer

This article is for information purposes only and does not form a recommendation to invest. The value of an investment may fall. Investing in precious metals, shares and bonds may not be suitable for all investors, and if in doubt, an investor should seek advice from a qualified investment adviser.

Balanced Portfolio Theory

Buy gold to reduce your risk

A simple rule of investing states that the higher the risk of an investment the higher the return. This is the Risk Premium: The amount you get paid for taking the extra risk. So if you want to make lots of money you need to take more risks. It is however possible to reduce the risk by building a balanced portfolio.

The risk of buying a single share is high with many possible unknown influences on the share-price and future dividends. Buying two shares results in some reduction of risk because a crash in one share price may not affect the other one adversely. Many shares are highly correlated to each other, so having two shares in the same field (e.g. BP and Shell) does not reduce the risk as much as two shares in unrelated industries (e.g. BP and Lloyds) Similarly mixing shares with other asset-classes will also improve volatility of the over-all portfolio (e.g. mixing shares, bonds, property and gold bars)

Skip the maths in the next section if you prefer - this is just for illustration

The Maths (Skip this section if you prefer)

The risk of the portfolio of N assets can be expressed as follows:

Unfortunately these parameters are not readily available so accurately determining the optimum values for relative weights in the portfolio is difficult, but the equation does highlight the importance of uncorrelated assets. As the number of assets increases the value of xi2 gets far smaller and the first term of the equation far less significant and if the covariance ¤âij is small the second term is also small:

If N >> 1 then xi << 1

A portfolio with equally weighted investments in 10 uncorrelated assets would result in a risk of:

i.e. If each asset has equal risk the total risk is just a tenth of the risk of the individual assets. This of course is an extreme example, but does demonstrate the principle.

Insure Yourself Against Devaluation

Many people made the mistake of ignoring the equity, bond and precious metal markets in favour of property, making their portfolio extremely highly correlated to one market, and heavily geared (mortgaged) to improve returns or increase losses. Property may have seemed like a one-way bet, but most people have more than enough exposure to the property market through their own home. Having no exposure to property and a large equity exposure could also be risky, but having a mixture of uncorrelated assets would have reduced the pain of the property market or share market falls. Gold in particular has benefited from the fall in relative value of western currencies.

Financial advisors often provide a range of different suggested portfolio distributions depending on the income requirements and risk profile of the investor, how long before the money is required and what volatility or losses could be tolerated. Generally higher risk portfolios will consist of smaller shares or foreign equities and high-yield or emerging market bonds, income portfolios are usually blue-chip shares and bonds and low risk portfolios mostly government bonds and cash. In all cases mixing many assets with low correlation from different countries and different industries will reduce the risk. Gold is uncorrelated to other asset classes and tends to retain value even when other types of fiat money fall in value.

Many advisors recommend having 5% to 10% of gold, silver and other precious metals in your investment portfolio. This can be in the form of mining shares, ETFs, mutual funds although at least some of it should be in the form of real physical gold. Coins and gold bars can be bought from a broker with a significant premium over the value of the gold, alternatively there are always a lot of gold sovereigns and krugerands available on eBAY for a price close to the actual bullion value of the gold.

Please see my related article about how to invest in gold, silver and other precious metals

Related risk reduction article published on Helium

How to Get Exposure to Gold and Silver

mining shares

ETFs (Exchange Traded Funds)

mutual funds

Investment Trusts

real physical gold

Spreadbetting

Buying mining shares, mutual funds (unit trust or investment trusts in the UK) and ETFs can of course be done through a stock broker, coins and gold bars can be bought from a specialist coin dealer, but with a significant premium over the value of the gold, typically more than 10% for small quantities of coins to perhaps as low as 5% for large quantities of low quality bullion coins. High quality or rare coins will be more expensive, but should also retain that extra value.

An alternative and cheaper way to buy gold coins is on eBay, which is very easy and quite low risk. There are always a lot of gold sovereigns and krugerands available on eBAY for a price close to the actual bullion value of the gold.

Another, riskier, method for gaining gold or silver exposure is through spread-betting. I have written a separate lens on how to use spread-betting to reduce portfolio risk:

Pros and Cons of Owning Physical Gold and Silver

So why don't I just buy lots of gold and forget about shares, bonds, cash...?

Gold sounds too good to be true. When other markets and currencies get into trouble gold goes up in value, but there are a few reasons why gold should not make up too large a proportion of your portfolio.

Gold Does not pay a dividend

Shares, bonds and property investments often pay a dividend (or a "coupon" or rent), so even when markets go down you still get an income. Gold does not. It just sits there looking shiny.

Gold needs to be stored

Physical gold in the form of bars or coins needs to be stored safely somewhere. If it is just worth a few thousand dollars you can keep it under the bed and not worry too much, but for large amounts of gold you will need to pay a small premium for storage at a bank or insurance or of course you could buy a safe.

For large investments in gold an exchange traded fund (ETF) can make a sensible alternative (e.g. Lyxor Gold, GBS tracks the value of gold) without the storage hassles.

Investing in Physical Silver

Physical silver is also an interesting thing to buy for investing, but it is worth far less than gold, per ounce, so a significant investment in silver takes up a lot of space. Antique silver however is quite inexpensive compared to scrap silver and could be quite collectable.

Please leave me some feedback.

    0 of 8192 characters used
    Post Comment

    • Phillyfreeze profile image

      Ronald Tucker 4 years ago from Louisville, Kentucky

      My current allocations for my retirement account is: 30% Cash Equivalent, 30% Large Cap, 30% Small/Mid Cap and 10% International Stock...asset allocation can help one ride out the markets ups and downs and let you adjust your exposure to risk.

      Research from Vanguard, a well-regarded mutual fund company, shows thatwhen stocks and bonds were combined into an equally weighted portfolio, the portfolio experienced less risk than stocks alone, and still achieved an average annual return of 5.26% in all recessions between 1926 and 2008.

      Excellent lens on making wise investment decisions using a balanced portfolio mindset.

    • profile image

      waltergivensvig 5 years ago

      Hello guys, if you are interested in precious metals investment. Please visit http://www.verticalintegrationgroup.com.

    • profile image

      rockbridgeinvest 6 years ago

      We at Rockbridge came across an issues with gold. A person had bought gold, didn't recieve the gold and still had to pay taxes on this. This caused a lot of issues for this person. You can read more about that on our blog. http://www.rockbridgeinvest.com/tales-from-the-tax...

    • Countryluthier profile image

      E L Seaton 6 years ago from Virginia

      Great information on the metals. Got to look carefully at whether I want to put the matress over pounds of silver or get a few ounces of gold and put it in a valult. Keep up the good work!

    • profile image

      financialspreadbetting 7 years ago

      A new way to trade, $1 deposit, well worth a look, make money in any market

    • profile image

      julieannbrady 8 years ago

      Andy, "Don't put all your eggs in one basket" is great advice for just about anything in life -- no?

    • ElizabethJeanAl profile image

      ElizabethJeanAl 8 years ago

      The last time we sat down with our broker, our portfolio was in good shape. Today... The economy has really messed things up.

      Great lens, very informative.

      Lizzy

    • profile image

      Global_B2B 8 years ago

      You are part of my B2B Marketplace Headquarters business group so I thought I'd let you know about a new service I intend to start in a few days.

      I'm inviting you to become a subscriber to my weekly newsletter (free). Details on http://www.squidoo.com/groups/b2b-marketplace. Secure yourself a free membership!

    • profile image

      Global_B2B 8 years ago

      Great lens - very informative ! I rated it 5* I invite you to join my B2B Marketplace Headquarters group.

    • Rich-H profile image

      Rich 8 years ago from Surrey, United Kingdom

      My hubby was a banker in the UK. He's probably more qualified to read this than I, but I enjoyed your presentation of the information :)

    • SylvianeNuccio1 profile image

      SylvianeNuccio1 8 years ago

      Very interesting information and great presentation.

    • profile image

      Mayflowerblood 8 years ago

      interesting =]

    • nightbear lm profile image

      nightbear lm 8 years ago

      I understand the eggs in multiple baskets concept. This was a very deep lens. It will require many readings.

    • nightbear lm profile image

      nightbear lm 8 years ago

      I understand the eggs in multiple baskets concept. This was a very deep lens. It will require many readings.

    • ssuthep profile image

      ssuthep 8 years ago

      Great Tips. *****

    • TonyPayne profile image

      Tony Payne 8 years ago from Southampton, UK

      Very nice lens, great job. 5*****

    • Andy-Po profile image
      Author

      Andy 8 years ago from London, England

      [in reply to buylikebuffett]

      Yes. Very true. As a U.K. Investor I have done quite well by buying gold (up about 25% this year in sterling terms), because the currency has dropped relative to the dollar (and gold), making gold a reasonable hedge. Similarly when the dollar has fallen in the past, relative to other currencies, gold has acted as a good hedge. There are times, like these, when even a balanced portfolio will suffer.

    • profile image

      buylikebuffett 8 years ago

      I agree that diversification among different asset classes works best. However in this economic envirorment all asset classes have suffered. Gold, which is usually a safe haven when equities decline, has performed poorly. A deflationary environment harms all asset classes.

    • profile image

      Robyn_Abbatiello 8 years ago

      Great Job! 5*

    • profile image

      PetMemorialWorld 8 years ago

      Some excellent information and great tips.

    • profile image

      PetMemorialWorld 8 years ago

      Some excellent information and great tips.

    • profile image

      PetMemorialWorld 8 years ago

      Some excellent information and great tips.