Some portfolio types

Well, we have arrived at the final act of this guide; let’s conclude with some types of portfolios. When building a portfolio, you must first establish the investment objective. You have to ask yourself: why am I investing this money? What do I want to achieve? How do I want to achieve it? Over what period of time? These answers will determine which ETFs and/or ETCs you choose, since you have seen that ETFs, even with the same benchmark, may have different characteristics.

Obviously, they must be attainable objectives. Investing a thousand euros and hoping to make a million in 10 years is not feasible. Generally, those who invest do so to protect their savings from inflation, to have an annual (or six-monthly) income, or to supplement their pension when they reach the required age. These are all objectives that require different portfolios.

Next, you need to establish the time frame, i.e., how soon you want to achieve your goal. This depends not only on your age but also on the savings available to you.

Finally, you have to decide the risk you are willing to accept to achieve the goal, i.e., your risk appetite. As mentioned, greater gain also means greater risk. Investing in High Yield bonds allows you to earn more than investing in US government bonds, but the risk of default by an issuer is also higher.

Risk appetite can be understood as your tolerance for fluctuations, even sharp ones in some cases, in the value of the financial products you hold in your portfolio. You must quantify this risk and only choose the financial instruments that allow you to respect this parameter.

You need to evaluate everything well. If a goal can only be achieved by raising the risk beyond your tolerance threshold, then perhaps you should review your priorities and aim for something calmer and easier to achieve. It is also wrong to increase the size of your investment to achieve your goal: the savings you invest should not be needed for day-to-day expenses, and being temporarily without them should not cause you problems.

Now it is time to look at investment strategies depending on the goal you wish to achieve. First, there is a distinction to be made in portfolio management. Your portfolio can be managed:

• passively
• actively

What’s the difference? Managing a portfolio passively means buying ETFs and leaving them in the portfolio without making any changes for the duration of the investment. This has the virtue that you don’t have to spend time on it, at most a few hours a year, and the costs are almost negligible. However, keeping the same products in your portfolio at all times leaves it at the mercy of market fluctuations during periods of turbulence.

Actively managing a portfolio means buying and selling ETFs periodically as conditions change. It is immediately obvious that such management requires a lot more time, that costs increase because of the higher number of commissions paid on purchases and sales, and that it also requires a certain knowledge of market dynamics. The advantage is that you can modify your portfolio as economic and market conditions change. In theory, this can translate into higher performance with lower volatility and, consequently, lower risk, but it is not guaranteed: it depends on your ability to choose the right moment.

Regardless of which management you choose, you must respect your investment objectives and not get emotional, especially during turbulent market times. Everything goes well when the markets go up; the problems come when the markets go down. Too many investors panic and sell for fear of losing their savings, losing sight of the objective and time perspective.

I remember that in 2008 someone wrote to me saying they had invested in BTPs (Italian government bonds) and were worried about losing everything (or almost everything) because of the financial crisis and the collapse of the stock market. This happens when you don’t have a minimum of financial education.

Now, briefly, as this journey is not a solicitation to invest, I will show you three types of portfolios based on different needs.

1. Guaranteed capital portfolio. It is a strategy used by many banks to charge higher commissions. It consists of buying a zero-coupon bond and, with the difference between nominal value and market price, buying one or more ETFs. In the worst case, you will still receive the entire capital invested at maturity. For the sake of clarity, I will show you an example.

   I invest €10,000. I buy the XYX zero-coupon bond at 88.50 for an outlay of €8,850 and with the remaining €1,150 I buy an ETF. At maturity, the bond will return €10,000 to me (all my capital); the ETF will represent my gain.

   It is a type of conservative investment whose purpose is to preserve capital while making it grow. In this way, the risk is virtually eliminated (not entirely: there is always a risk, even if a small one, that the issuer defaults) and on top of that you have a gain, even if it is small. It is an excellent alternative to leaving your savings idle on your current account, where they are eroded by inflation every year.

2. Periodic income portfolio. Expenses: we all have them. Mortgage or rent to pay, children’s school, medical or life insurance, etc. So, it wouldn’t hurt to receive a periodic income (usually semi-annual or annual) to help cover them.

   First, you have to choose ETFs that distribute returns (and not accumulate them). Then, to create this type of portfolio you have two options:

   • stocks
   • bonds

   You have to choose whether to use ETFs on the stock markets or the bond markets. There is a difference, which I will now explain. Of the two, equities have often distributed a higher return, although this is not always the case and depends on the historical period. However, stocks are less regular and more volatile and therefore subject to declines (sometimes strong ones, as has happened in the past). Even if, in the long term, they do not cause your investment any problems, they can give you issues with dividends. This is both because a company could close the year at a loss, and because, even if a profit has been made, the company may decide not to distribute dividends to shareholders (in practice, choosing to retain the profit for that year rather than distribute it).

   Bonds, instead, are far calmer and more constant, without such great swings: they are a lot less volatile than stocks and therefore more suitable for those who need a regular income every six or twelve months. In my opinion, therefore, bond ETFs are to be preferred.

   The second and final step concerns the choice of ETF. You have to choose a “high yield” ETF which, all other conditions being equal (liquidity, physical or synthetic replication, currency, etc.), has the highest yield (distribution yield). The JustETF screener can help you make your choice.

   Therefore, this type of portfolio is ideal for those who need to obtain a periodic income with a medium-to-long-term perspective. Moreover, being constructed entirely out of bonds, it is generally less volatile than an equity portfolio. Be careful, though: high-yield bonds can be as risky as equities, or even riskier, if you do not know well the situation of the issuers or of the States you are investing in. Just look at Argentina, which has defaulted on its debt several times, or at Greece, whose bondholders suffered heavy losses when its debt was restructured in 2012.

3. Retirement portfolio. Whatever country you live in, it is well known that once you retire, what you receive each month will be less than your salary. You will be forced to use your savings to maintain your standard of living. This is a common concern for many people.

   To get around this problem there are pension funds, whose main purpose is to supplement your pension, or, much more simply, accumulation ETFs.

   The strategy that I adopt is the Accumulation Plan (but it is not the only one available). It consists of not investing all your savings immediately but rather breaking them up into monthly purchases, or at whatever interval you prefer (quarterly, six-monthly, annual).

   This strategy is also great for people who do not have the capital to invest but who are able to save every month and put those savings into an accumulation plan, particularly young people. This is a subject that is very close to my heart: young people. They have two great allies in this strategy: plenty of time ahead of them and compound interest. Even with a little each month, a 25-year-old can build a financially sound future.

   Your age should decide which ETF to buy. If you still have many years before retiring, then the best strategy is to invest in an equity ETF (on world or US equities) that guarantees better performance in the long run. If, on the other hand, you only have a few years left before retirement, then it is wiser to invest in a bond ETF (also global or US) that is more conservative and less volatile.

   The accumulation plan is very simple to implement and does not require any special knowledge. It does not require much time, at most a couple of hours per month. It solves the question of whether now is the right time to buy, since purchases spread over time will give you an acceptable average price. You can customise it to your liking.

These are just three types of portfolios, but there are many more. It’s up to you now, if you are interested, to delve into this topic and build the one that best suits your needs.