As we announced, we are today launching a new series of articles dedicated to an in-depth analysis of different asset allocation strategies. Our evaluation will not be limited to performance alone, but will also include a detailed study of the associated risks. In my book "The determinants of wealth"I have already carefully reviewed many investment portfolios. For this series, rather than reviewing all of these portfolios, we will focus first on the most popular strategies, before exploring more innovative and less conventional approaches.
ETFs
I will take this opportunity to address the topic of ETFs (exchange-traded funds), which constitute the different asset classes within investment portfolios. Their growth is so rapid that they could soon outnumber listed companies themselves. Current statistics show that there is now one ETF for every four companies present on global stock markets. While the number of listed companies is increasing by only 3 billion annually, the number of ETFs is growing spectacularly by almost 15 billion per year. This proliferation makes navigating the ETF universe increasingly complex. We observe a striking paradox here: these financial instruments, initially designed to simplify investment by consolidating the offer, end up creating a counterproductive fragmentation of the market.
The importance of asset allocation
Why talk about portfolios? Isn't it more important to focus on individual stocks or to invest directly in an ETF which already constitutes, as such, a portfolio?
First and foremost, it is important to respect the fundamental principle of diversification, as popular wisdom points out: "You should not put all your eggs in one basket". For example, a portfolio composed of only twenty or so Swiss company stocks cannot be considered truly diversified. The problem lies not so much in the number of stocks held, but rather in the double concentration of risks: on the one hand, on a single asset class - equities - and on the other hand, on a single geographical area. This monolithic approach exposes the investor to excessive vulnerability to market fluctuations.
Furthermore, it should be noted that holding a single ETF, even a highly diversified one, is not without risks. Let us take as an illustration the case of GAL, managed by SPDR (SSGA). Its current composition is as follows: one third in US stocks, one quarter in international stocks (excluding the US), one third in bonds and the balance in cash. The intrinsic composition of this ETF is not problematic in itself - on the contrary, it even presents a level of diversification that is quite appreciable for an instrument of this type.
The major issue is the excessive concentration of the portfolio in a single ETF. Although the issuer SSGA has a solid reputation, it would be unwise to completely dismiss the risks of fraud or counterparty default. Recent financial history has shown us, time and again, that even the most prestigious and seemingly unshakeable financial institutions can suffer dramatic setbacks. Therefore, it is unwise to invest a substantial portion of one’s capital in a single ETF (except for novice investors with modest assets, for whom this approach can be a pragmatic starting point in their investment journey).
Volatility
The second major reason to pay particular attention to the allocation of one's assets lies in the control of the volatility. The latter is intrinsically linked to a judicious and methodical diversification of the constituent elements of the investment portfolio. Although performance remains an essential criterion, it cannot be considered as the sole decision-making factor. If this were the case, investors would concentrate their investments exclusively on bitcoin, whose average annual return exceeds 100 %. At such a rate of return, everyone would quickly become wealthy. If this strategy is not universally adopted, it is because it involves significant risks that should be taken into consideration.
First, even when we consider ourselves psychologically strong, we generally tend to considerably minimize the influence of stock market fluctuations on our emotional state and, consequently, on our ability to make rational decisions. Maintaining one's composure in the face of fluctuations in the financial markets is particularly tricky, because we are naturally inclined to become overly enthusiastic about sharp rises and, conversely, to panic during significant falls.
Moreover, the future remains, by its very nature, unpredictable. Although the Bitcoin has experienced a spectacular rise over the last decade, no one can predict with certainty its future evolution. This cryptocurrency could continue its remarkable growth over the next ten years, maintain a certain stability, or on the contrary, experience a significant decline that would bring it back to its initial values. Caution and a long-term perspective therefore remain essential in the face of these uncertainties inherent in financial markets.
Finally, as I develop in detail in my book, volatility is a major intrinsic risk, particularly during the capital withdrawal phase. An asset allocation that is too exposed to risky investments and presents inadequate diversification can seriously compromise financial sustainability and lead to a shortage of resources at a critical moment. This vulnerability must be anticipated and managed with the greatest care in any long-term investment strategy.
Therefore, judicious diversification of asset classes within a portfolio is essential, thus making it possible to effectively control and mitigate all of these financial risks.
Our next article will be dedicated to an in-depth analysis of ETFs (exchange traded funds). Even if you prefer to invest directly in stocks, bonds, gold or real estate, it is relevant to take an interest in these financial instruments. Indeed, the majority of them replicate indices and thus represent different asset classes. This characteristic makes them valuable tools for optimizing the structuring of an investment portfolio, whether or not we choose to integrate them into our final strategy.
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Very relevant and useful content, as always. Looking forward to the next article...Thanks!
Thank you Patience. The next article (on ETFs) is already well advanced. It still needs a few days of work, because the more I advance on the subject, the more it raises secondary questions.