How to form a long-term investment portfolio correctly?

What an investor needs to know and consider when forming an investment portfolio

The essence and purpose of compiling a long-term investment portfolio is to develop an investment strategy for a long investment horizon, at least 5-10 years. This, in turn, dictates all other parameters of the portfolio, and the composition of the assets of this long-term portfolio.

Key parameters of a long-term portfolio:

base currency of the portfolio;
tax wishes and features of the investor;
type of investment strategy Value/Growth/Blended;
benchmark (Benchmark), usually S&P500 Index;
Risk-Free Rate;
portfolio investment horizon;
target expected portfolio return;
target Volatility (Standard Deviation) of the portfolio;
target portfolio Beta;
number of assets in the portfolio;
restrictions on the position size in the portfolio (Min % and Max %);
diversification by asset classes;
geographical diversification;
diversification by sectors of the economy;
frequency of portfolio rebalancing;

What should you be prepared for when investing in stocks for the long term?

Throughout the entire period of investment in the global economy and in the life of the investor himself, various events may occur that must be taken into account when developing an investment portfolio for a long-term investor. You need to be prepared for the fact that the value of portfolio assets can fluctuate significantly, grow and fall, individual shares can lose a significant part of their current value at the moment.

Also, in the life of the investor himself (the owner of a long-term portfolio), unforeseen situations of an extreme nature, failures, ups and downs can occur, family circumstances, business problems and much more can change. At such moments in life, an investor may have an urgent need to have access to a part of the portfolio's assets. That is, the investor will need (or would like to) sell part of the portfolio assets and withdraw cash to his own account for urgent current or unexpected purposes.

Such withdrawals of funds from the portfolio may have a negative impact on the long-term performance of the portfolio, and if the situation on the market and in the economy is difficult, then this may lead to fixing part of the losses or receiving less profitability.

Of course, such situations can be foreseen and a part of the portfolio's assets can be kept in cash or cash equivalents. But here, in any case, you need to keep in mind that the non-performing part of the capital will be subject to inflation and we do not recommend keeping more than 10% in cash. Depending on the size of the portfolio, this may be 5 or 3% of the amount of the initial value of the portfolio.

It should also be borne in mind that when fixing profits, the investor has obligations to pay taxes, which might not exist if positions were not closed urgently.

Risk tolerance will help you understand what assets should be selected in the portfolio

Each investor, depending on his degree of tolerance for risk and profitability, may have a portfolio that is different in composition and structure. This is dictated by the fact that conservative investors need less volatility and market risk of the portfolio (and as a result, they will be satisfied with lower returns). And for more aggressive investors, they need more volatility and market risk (Beta) of the portfolio (they need more expected returns).

In order to obtain such parameters of risk and expected return, it is necessary to build an investment portfolio with a different composition of positions, assets will differ in terms of Beta and Standard Deviation, PE Ratio, ROE, Debt / Equity, EV / EBITDA, as well as other important metrics.

That is, the investor's risk tolerance will help to understand which stocks and funds should be selected in the portfolio and which sectors of the economy will be involved in this portfolio, and what kind of Value/Growth/Blended strategy it will be.

Investment objectives influence the risk-adjusted investment horizon

Prior to the development of an investment strategy, we recommend that you engage in financial planning and goal setting. The investor will need to determine his long-term financial goal or group of goals, which can be calculated by our specialists taking into account the expected inflation in order to get the target amount in real terms, and not in nominal terms.

As a rule, the goal is a certain amount after a certain period of time, which will be spent on the acquisition of tangible assets, houses, yachts, land, commercial real estate, etc.

The goal of a long-term investor can also be the amount to maintain the level of consumption or standard of living, that is, to receive a monthly income from a certain age. Part of the capital will be withdrawn from the portfolio and transferred to a personal card account for the current needs of the investor.

Such calculations will include the initial amount of capital with which the investment portfolio will start. Knowing the initial amount of the portfolio and knowing the target amount of the portfolio in 10-15 years, it is possible to calculate the annual target growth of the portfolio, as well as adjust it for inflation.

Thus, the initial amount of the portfolio, the investment goal and the expected inflation will directly affect the investment horizon, since under normal economic conditions, the target increase in the value of the portfolio will always be limited by the risk and return parameters of the portfolio. A portfolio risk, as you know, depends on the degree of investor tolerance for risk.

In simple words, to go the distance, it is important to move at a certain speed, but this speed will depend on the speed limit of your investment car! Therefore, if your car has a low speed, then it will not reach the goal as quickly as it could be the case with a faster car. You can reach the same goal either earlier or later, it all depends on the speed of your investment machine.

Why should inflation be taken into account when investing long-term?

Throughout the entire investment period, inflation will mercilessly eat into the real purchasing power of your portfolio, so inflation will need to be taken into account and included in the calculations when drawing up a financial plan. Otherwise, in the future, the value of the target purchase may be greater than the value of the investor's portfolio, and there will not be enough money for the acquisition.

An investor, when calculating his investment goal, must take into account inflation, which is expected in the next year or in the next 2-3 years. Historical inflation is of little help since investments are planned for the future, and it is important to understand how to adjust the portfolio parameters for the coming year so that in real terms the investment portfolio gets closer to the goal, not further.

The compound interest factor helps to increase capital and the investor's money works more efficiently on average in the long run. But, inflation at the same time inexorably does the opposite, it reduces the value of money in real terms.

If an investor wants to buy a country house with a plot, let's say his portfolio grew by 15% per year, and inflation increased the cost of the house, for example, by 3%, then as a result, the investor moved towards the goal in real terms by 12% per year (and not 15 % as planned). At this rate, in 10 years, the price of a house will be 30% more expensive in nominal terms.

Why is it better to turn to experts in financial planning?

If these inflationary effects are not taken into account when financial planning and forecasting the target parameters of a long-term portfolio, then in the end the investor may not achieve his cherished goal and, as a result, will be disappointed.

However, if you contact our company, we will be happy to help you plan your financial goals correctly and competently draw up a long-term investment portfolio that will work for the result you want to get.

We will also help you optimize the tax burrows that will definitely arise when making a profit from investments. Every year, the investor is required to pay taxes as a result of the work of the investment portfolio, but our specialists will be able to advise and explain to you how you can legally reduce the tax burden and make this money work in your portfolio.

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Zair Iusupov is an investment architect, a specialist in building portfolio solutions for private investors, business owners, HNWI and UHNWI clients. He has expertise in the field of financial engineering, portfolio investment risk management, strategic asset allocation and development of individual investment solutions.

He specializes in developing portfolio strategies for investors with capital of $300K–$5M+, combining in-depth macroeconomic analysis, fundamental assessment of US and European companies, Strategic Asset Allocation, Investment Policy Statement, a quantitative approach to risk assessment and long-term investment discipline.

Zair Iusupov

Founder and Chief Investment Officer

Wealth Management and Private Advisory (US, EU)

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