Sizing Up: How to Build a Well-Rounded Portfolio

Sizing Up: How to Build a Well-Rounded Portfolio

With global stocks and bonds down big, there’s never been a better time to piece your portfolio together.

Sizing Up: How to Build a Well-Rounded Portfolio
Noah Weidner

Updated Oct 26, 2022

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Stocks

Stocks

Bonds

Bonds

Balanced Investing

Balanced Investing

  • Financial markets can be unpredictable, so it's wise to make long-lasting investments
  • Investors use 401(K)s and IRAs to avoid overpaying taxes on income and gains
  • Follow financial advisors and seasoned investors to find the ideal allocations of stocks, bonds, cash, and alternatives for your portfolio


Over the last three years, global markets have seen their highest highs, lowest lows, and fraught with market volatility—no amount of bonds, dividend stocks, or tech companies are helping investors avoid losses.

Traditional markets have fallen over 20% in 2022, which also happened after they were slayed by the pandemic in 2020. It also happened during the Trump ‘tariff talk’ with China in 2018, the U.S. credit downgrade in 2011, and the Great Recession of 2007. At face, you can tell that markets are fickle things—a potential hazard for your wealth.

In reality, creating and sticking to a well-rounded long-term financial plan is the best way to keep the manic market from stealing your hard-earned cash

That’s why it pays to play long and steady with your investments and to craft a well-rounded, long-term plan for your money. Many employ financial advisors to help craft such a plan, but the rise of neobanks and fintechs has allowed the average person own their money—choosing the right amount of account risk and position sizing for your goals.

Let's start by looking at one of the most famous portfolios of our age: the 60/40.

Why allocating the old-fashioned way didn’t work

Four of the most dangerous words in investing are “this time is different.”

However, 2022 is different from anything the last generation of investors have seen. Stocks and bonds have fallen more than 20%, global inflation is threatening returns and earnings quality, high commodity prices are creating major headwinds in global economies, and interest rates are on the rise.

One portfolio designed to counter the risks of such situations has offered little reprieve in 2022—the famous 60/40 portfolio, which is 60% stocks and 40% bonds. It’s down more than 20% from its peak, thanks to the simultaneous fall in the bond and stock markets.

If you’re thinking, "well, that’s not how it’s supposed to work," you’d mostly be right. The correlation between the bond and stock markets is unusual over the last decade. According to Bloomberg, the 10-year average of bond-stock correlation is minus 25%, but it hit a 23-year high of positive 45% in 2022.

Things could start heading north for the old-fashioned 60/40 portfolio, especially with stocks and bonds at discounts to their recent highs, but it already revealed its weaknesses.

Here’s how to do it differently.

Why advisors use age for position sizing

If you’re alive and making money, you’re probably saving and investing. If not, you’re making a big mistake—that’s probably why you’re reading this article.

Sooner or later, you’ll probably sign up for a platform or consult a financial advisor that will hand you a sample allocation that looks something like this:

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T. Rowe Price’s recommended allocations by age. 

Source: troweprice.com

A retirement position sizing strategy based on age is one of the most popular techniques. You might even discern the 60/40 strategy’s cameo. That said, there’s little proprietary about this approach to trading—many financial advisors use something like this as a baseline target for clients.

Implicitly, the message here is that younger people should take on more risk by allocating more of their portfolios to stocks. The opposite is true of older people, who generally value easier access to their money. Almost all advisors recommend that older people put a higher percentage of their money in liquid assets such as cash, bonds, and money market funds.

 

This is a tried and true method for proper position sizing. If you ask an advisor, age-based position sizing is one of the largest factors—look no further than target date funds. Fund issuers made hefty fees by selling their age-specific trading strategy to retirement plans and employees for an entire generation.

Why age isn’t enough for position sizing

While retirement position sizing is useful, it ultimately has shortcomings. First, it only considers the mix of stocks, bonds, and money market funds—the asset mix for many Americans has become more imaginative. Many now use robo advisors to manage their retirement portfolios and have their cash in high-yield neobanks. They use crypto-friendly institutions, own alternatives like Bitcoin, and hold tangible assets like blue-chip art and fine spirits.

This is where it pays to depart from age-based allocation. And it pays to ask—even if you're 20, 40, or 60—how did you feel seeing your portfolio fall in 2008, 2011, 2018, 2020, and 2022? Your risk tolerance is an ingredient that isn't considered in the asset allocation for retirement.

That’s because certain kinds of bonds and stocks are riskier than other assets. For example, an actively-managed portfolio like ARK Invest’s flagship ETF will be way riskier than a good old-fashioned S&P 500 index fund.

However, the amount of financial platforms and asset types you use is one prescription for your risk appetite. Are you just trading stocks and bonds? Do you have private companies in your trading account? Do you have some other novel trading instrument in your IRA? All of these are important considerations when it comes to weighing position size.

How does position sizing impact your investing accounts?

Experienced traders will tell you that position sizing is one of the most important forms of risk management—not doing it right will cause you to lose money. We’ll start with the basics: your bank account and retirement accounts. 

Making bank with your bank

Let’s start with the cold hard facts about your cash. Many advisors recommend keeping an emergency fund on hand—usually three to six months of expenses, but it can be a fixed dollar amount like $10,000 or $25,000. You can also keep a percentage of your net worth—say 5% of all your money—in savings. This might look different when you're retired, especially if you’re drawing from retirement accounts.

Whether young or old, having a high-yield savings account on platforms like Chime or Axos is crucial. Higher interest rates trickle down to customers and turn the cash-rich even richer. As of October 2022, Juno is offering 5% APY on balances up to $10,000, then 3% on balances between $10,000 and $250,000.

Long-haul investing with qualified retirement accounts

And now that we’ve had our money talk, let’s discuss retirement accounts—the place to stow cash you’ll need when your knees hurt. These things are a gem, so if you’re not maxing them, then you’re missing out on tax savings galore. Before anything else, crank the contributions on your 401(K), Roth accounts, or other qualified account up to the max. 

Before contributing to a retirement account, understand withdrawal limitations and how they might fit into (or conflict with) your goals. Platforms like Wealthfront offer advisory services and recommendations for how to put any dollar amount to work.

wealthfront
Wealthfront

4.5

Robo Advisor

What to do once you’ve checked off retirement and savings goals

Once you’ve maxed out your retirement accounts, the sky's the limit for you—but don’t get ahead of yourself. Savings and retirement accounts are prerequisites for your financial health, but you still need to be conscious about what’s sitting in your portfolio. Diversification doesn’t mean owning lots of different funds and testing ten trillion different things.

At least at first, it means making sure nobody's making money from you paying fees or benefiting from your asset placement (diversified funds like the Nasdaq or S&P 500 are better for retirement accounts than individual stocks and bonds).

Putting money to work—whether in savings, a retirement account, a brokerage account, alternatives, or another trading instrument—is meant to be synergistic. In other words, it’s meant to benefit your broader portfolio as a whole. 

Investing or saving in too many different things can make it hard to keep track of. Finding a balance is critical to achieving correct position size and growing your trading capital.

How Does Position Sizing Work For Alternatives?

If you’re heavily contributing to your savings and retirement accounts, you might be looking at a significant portion of your wealth sitting there. But how should you tackle investing in things like luxury French wines or vintage comic books?

Alternative assets have a lot of great things going for them right now. Many are market-agnostic, meaning they're uncorrelated to stock indices like the S&P 500 or Nasdaq-100. So when you’re penciling in a position size for alternatives, there are many other factors to consider other than public sentiment.

Alternative investing is a matter of comfort, though. If your temperature for investing and personal finance isn’t very hot, then alts might not be a great use of your time. But if you’re invested—literally and figuratively—in these assets, they might deserve a cut of your portfolio. With a little research, you could even identify alternatives that reduce your overall risk by hedge against other allocations.

Analysts recommend investing anywhere from 10% to 20% in alternative asset classes to those who can afford to. That means people in good financial health, those maxing their retirement accounts, and folks with abundant savings on hand should have some exposure to alternatives. In other words, if you haven’t amassed a pretty penny in diversified stock and bond funds, you might want to weigh a lower alternatives allocation (or none at all).

How to Keep Position Sizing Working For You

Whether you’re a seasoned investor or a noob, you’ll find position sizing waiting for you at every corner—whether it’s a financial advisor recommending you to buy something, a TikTok influencer shilling shitcoins, or you conducting research online.

In reality, creating and sticking to a well-rounded long-term financial plan is the best way to keep the manic market from stealing your hard-earned cash. While people would like the ingredients of instant wealth or a trading strategy that turns them into overnight millionaires, the best ingredient to wealth creation is prudent financial decisions.

That means you shouldn't bet it all on a single trade. Do your research, consider the risks of each trade, learn how financial advisors size positions for clients, or even ask an expert yourself. 

Adding investments to your paycheck budget

To stay the course, it might pay to create a budget and maintain various investment accounts. That budget will include rent or mortgage payments, food, transportation, and other things for many investors. Then, it’s up to you to figure out what portion of your monthly income to carve out for long-term investments.

For example, say you make $2,000 after tax—which is near the median U.S. household biweekly take-home pay. You might put $1,000 of that $2,000 bimonthly paycheck towards rent, $750 towards essentials, and $250 towards retirement accounts and savings. Ultimately, you have flexibility in how to do this—and you might even be able to reduce bills like student loans by doing it soon.

To hold yourself accountable to your retirement goals, you might check if your employer offers a pre-tax qualified retirement plan like a 401(K). They’ll whisk your cash away before taxes are taken out of it, allowing interest to work in your retirement plan's favor. This could be a good option for undisciplined spenders who don’t urgently need their cash each month.

Ultimately, the sky's the limit when it comes to allocating and position sizing. However, the most constructive way to put together a portfolio is with the recommendations of financial professionals, online resources from experts, input from robo advisors, and platforms dedicated to helping people build wealth.

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