4 Major Mistakes when Building a Portfolio

The following four major mistakes when building a portfolio are not the only errors that can be made, but are amongst the most common. While no portfolio is perfect for all investors or in all types of markets, following a basic framework and avoiding certain common mistakes is a logical way to improve your odds.

1. Failure to Create a Comprehensive Investment Profile

Before you deploy a single dollar into a single investment, developing a comprehensive investment profile is advisable. This activity will define your risk tolerance, your investment objective, and your time horizon. Without know each of these, it is very difficult, if not impossible, to build a portfolio that will yield the results you want. Time horizon defines how long you have to reach your investment objectives. Risk tolerance defines what asset classes and industry allocations can be considered. In the absence of this information, you will be basing critical decisions on arbitrary factors.

2. Failure to Properly Diversify across Asset Classes

Unless you have an extremely targeted investment objective, diversifying across asset classes is a part of building a successful portfolio. The returns offered by different asset classes tend to be uncorrelated. This means that when one type of asset is performing well, another may be struggling since there is no connection between these returns. This is important because no asset class always goes up. The risk and return trade-off is worth ensuring that you have some segment of your portfolio that is proving positive performance when other areas are struggling.

3. Failure to Properly Diversify across Industry

Similar to the need for proper diversification across asset classes, you need to make sure that your equity investments represent a broad slice of the stock market. Many investors make the mistake of focusing too much of their portfolio on highly visible sectors. Having exposure to these industries is appropriate, but you need to have exposure to all industries. Investing in an ETF or indexed product is one way to force this diversification into your portfolio, but you need to distinguish between active and passive investing.

4. Buying Story Stocks as Long-Term Investment

One of the most common mistakes that you can make when building an investment portfolio is to make long-term investments in story stocks. A story stock is one that is expected to perform well in the near-term based on its “story.” This can range from a soft drink maker releasing a new product, to the change in a government regulation having an impact of a utility company. The story drives the price in the near-term, but you need to follow the story and close the position after the move has happened. Too often, the story drive the purchase of the stock and then it becomes a core holding for no other reason.

While there are many other important mistakes that you should avoid when building your portfolio, these are some of the basic. Avoiding these will have an immediate positive impact on your long-term success.

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