I was having a small debate recently with a financial adviser friend regarding portfolio allocation and the place of bonds in a portfolio. The main point of the debate was whether measuring the investment risk of the portfolio by the ratio of bonds to stocks/equities was at all practical.
Bonds are basically debt instruments by the issuers. In simpler words, an IOU. By buying a bond, bondholders are lending their money to the issuer, in return for interest.
Bonds vs Stocks
Most investors who buy into bonds are going after the “guaranteed static yield” that bonds provide. While it may seem many people think that bonds are thought to be safer due to this “guaranteed yield” and lessened volatility, it is nowhere near safe as people think them to be. This is in contrast to what many financial advisers and professionals will claim. In fact, it’s pretty common for advisers to measure the investment risk in a portfolio by the ratio of bonds to stocks. … Read the rest
“[Soros taught me] it’s not whether you’re right or wrong that’s important, but how much money you make when you’re right and how much you lose when you’re wrong.” – Stanley Druckenmiller.
The conventional wisdom a typical investment advisor will say, “Diversify your risks. Your portfolio should be divided among equities, bonds and cash.”
However, what irks me the most is when it is mentioned that to have higher return equates to taking on higher risks. Equities carry higher risk than bonds. Therefore, it is important to diversify your portfolio among the various investments of the various risk levels. This logic cannot be more flawed; diversification for its own sake is not at all sensible.
As an investor, my key tasks are capital allocation based on the expectancy of your return on invested capital and more importantly, risk reduction.
The best investors such as Warren Buffett are terrific risk managers. To George Soros, success in investment comes from “preservation of capital and home runs.”
Diversification may minimize risk, but at the same time, it can have an adverse side effect on profit potential.… Read the rest
Most people seek to find an edge in investment in making money in the shortest time frame possible. A common consensus among value investors is to screen and locate stocks that are mispriced by the market by means of information arbitrage. This makes it more exciting to uncover a small cap stock that can be the next Amazon, Tesla, Netflix or Facebook – something that the market haven’t noticed yet. However, given today’s technology and information network, information travels faster than ever before. The informational gap between small cap stocks and large cap stocks is smaller than many of us realise and informational advantage over others is not as easy to obtain as before.
However, the most underrated advantage to have as an investor is time. This creates a huge advantage for investors who choose to focus on a longer time horizon. Just as investors we are looking for companies with quality management that focus on creating long term shareholder value, we also must be patient and focus on the long term vision of the company.… Read the rest