Investments in stocks and funds: how can an investor not lose capital?

When investing in the stock market, situations often arise when the market falls rapidly or corrects. Such fluctuations in the stock market, shares of companies, funds or ETFs are also reflected in the value of the investor's portfolio. Depending on the degree of portfolio risk, the value of an investor's portfolio can fall either faster or slower than the S&P500 broad market index.

In such a scenario, an inexperienced investor can close his open positions and fix a loss or fix a smaller profit, taking into account the drawdown, that is, on the fall of the market. This is a loss of capital, especially if the value of the investor's portfolio has fallen below its initial value.

The optimal number of assets in the portfolio

Depending on the size of the investor's portfolio, approximately 20-25 assets in the long-term investor's portfolio are optimal with a capital amount of 300,000 USD or more. Investment portfolios with less capital may have a different optimal number of assets. For example, 12-15 assets. At the same time, it is recommended to invest 50-60% of the portfolio in index funds of the broad market or in sectoral ETFs of the American sectors of the economy.

The remaining 50-40% of the portfolio can be invested in individual stocks, but they need to be properly analyzed before being selected for your portfolio. That is, you need to analyze the fundamental data of each company and choose the best time to buy and an acceptable price level for this asset.

Strategic structure of the investment portfolio

In terms of risk diversification, there is a strategic level at which to decide on the portfolio structure and allocate capital across asset classes and countries. The choice of the investment country is related to the currency in which the asset will be purchased. And this currency usually has its own country level of inflation. This should be kept in mind when allocating capital across countries and currency areas.

In terms of portfolio structure by asset class, there are four main asset classes: Equity; bonds (Fixed Income); real estate (Real Estate); cash and their equivalents (Cash and Equivalents). Each asset class has its own degree of risk, the combination of all these classes eventually forms the degree of risk of the entire investment portfolio. As a rule, stocks and real estate have a greater degree of risk than bonds and cash.

The less risky the investor himself is, the more conservative the portfolio structure he needs. In adulthood, investors prefer not to lose their existing capital, have a low portfolio return, but at the same time have a low level of volatility.

Portfolio diversification across various sectors of the economy

When we turn to diversification at the level of sectors of the economy, we need to keep in mind that each individual sector is, in fact, a group of almost homogeneous companies. The businesses of these companies are very similar and have similar share price behavior.

At the same time, it is important to understand that each sector is also divided into industries that group the closest competing companies to each other. That is, a sector of the economy can include both 30 and 50 companies, but they are also divided into industries in which a smaller number of companies are grouped. Every industry has its own structure and degree of competition.

For a long-term investor, it is important to protect your capital and diversify into sectors of the economy that have unrelated macroeconomic factors. For example, pharmaceuticals have a low correlation with oil companies, while logistics, for example, has a high correlation with retail. Or HoReCa, entertainment and gaming business are closely related to the restaurant business (eg MacDonald's: MCD, Chipotle Mexican Grill: CMG).

When the economy is growing, business cycle sensitive companies outperform other companies, their stocks rising faster than the S&P500 broad market index. These companies tend to have a high degree of market risk and volatility, and the value of these stocks rises much faster than the index. The reverse is also true: when the market is down and the economy is stagnating, these stocks are falling faster than the broad market index.

How to allocate capital in an investment portfolio

The distribution of capital and risk in a portfolio is a complex process and is performed on the basis of mathematical and statistical calculations. An ordinary and inexperienced investor is unlikely to be able to independently correctly perform such diversification.

In principle, it is naive to distribute capital equally among different assets, but this will not be efficient. We recommend contacting professionals who make investment risk diversification correctly and competently. A professional approach to risk management involves building an efficiency frontier and a Capital Allocation Line that will display the most acceptable risk/reward ratio for a specific set of assets in an investor's portfolio.

At the same time, it is necessary to decide how much risk the investor wants to take on. That is, a portfolio can have parameters that are either more risky or less risky, everything will depend on the level of investor's risk tolerance. The composition of the investor's portfolio will also depend on the degree of risk tolerance, it may be necessary to replace some of the positions with more risky ones or, on the contrary, include less risky assets in the portfolio.

All of the above methods of minimizing risk and allocating capital in the portfolio should increase the investor's portfolio risk resistance and allow saving capital without resorting to forced closing of positions and, as a result, fixing a loss or losing part of the profit!

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