Calculation for balancing portfolio percentage vs. risk

Question

Disclaimer: I'm a complete novice to investment, so please adjust the style of your answer accordingly.

There are some good questions on this site about "what percentage of my portfolio should I keep for X?" for things like stocks and gold. While those are good, specific answers, I'm looking for a generalization: how do I balance risk vs. diversity vs. ROI vs. whatever and figure out what percentage of my portfolio should be allocated to which investments?

My personal profile is to go for steady, long-term growth. I assume, therefore, that riskier investments should be a smaller percentage of my overall portfolio. I don't know how much smaller though; should I confine it to only 10-15%? Should it be at most, half of my baseline/normal investments?

Answer 1

I am a retired investment advisor (25 yr career) dealing with small businesses, individual investors and pension plans.

1. Considering that risk has many different meanings (i.e. risk of principal loss, risk of lost opportunity-being out of the market at the wrong time, liquidity risk- needing to sell when there are no buyers, foreign currency fluctuation risk, taxes, etc. Some of these risks aren't relevant to you, of course, but until you think carefully about each of these, you'll be confused. Try prioritizing them.
2. Each asset class has a different risk profile- cash has no volatility, but no appreciation ability, listed corporate bonds have greater return than cash, but include default risk, equities have greater risks/rewards than bonds, etc.
3. What is your overall goal, over what period of time? Is getting access to your investment a requirement whenever necessary?
4. A common procedure for investment advisors is to quantify an investors' profile including: risk tolerance, time horizon, tax situation, etc. Then to find "the sweet spot" for a given asset allocation along a risk spectrum. It's not simple.
5. You might investigate Vanguard funds investor questionaire: https://personal.vanguard.com/us/FundsInvQuestionnaire. It's useful tool to think about your situation, though their recommended allocation is likely to be simplistic.
6. How much money are you considering? If you have more money, it's easier to diversify, but keeping track of it takes time. As a "complete novice" it's likely you don't have much $$$, so start small (i.e. $5000 or so), pick a common allocation of 60/40 equities/fixed income, select 2-3 mutual funds each from the above split from Vanguard (based on low expense ratios), and see what happens. Pay attention, as investment knowledge is hard won, takes time and patience, and can be intellectually rewarding. Don't get scared or euphoric when things happen- above all, READ the statements.

Answer 2

Don't jump into risky assets by walking into someone's office with zero risk and walking out with 40%. Your tolerance is personal and you won't know how your gut reacts until you hold risky assets and live though a market drop. So add them slowly and don't go above 30% (say no magic number) before you have experience big drops. (they happen every 5 yrs or so).