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The Boost: Constructing the right portfolio

October 26, 2023

Last week we discussed how to appropriately evaluate your portfolio performance through benchmarking. As we shared, one of the key aspects of benchmarking is understanding what you own and your investment goals. This week we discuss building a portfolio that meets your goals.

🧠 What you need to know

Two popular portfolio types at opposite ends of the spectrum:

  • A concentrated portfolio hones in on a small number of investments. Perhaps you really believe in tech and decide to allocate 100% of your capital to just Apple, Amazon, Microsoft, Tesla, and Google.
  • A diversified portfolio is the “don’t put all your eggs in one basket” portfolio. For example, you could invest 20% each in sectors like tech, healthcare, consumer goods, financials, and real estate through five exchange traded funds (ETFs) or in 20 to 30 individual stocks to match that allocation.

📊 Choosing the right one for you

The concentrated portfolio

Let’s take the example allocation from above. An equally allocated portfolio to those five tech stocks has returned 17.7% over the past year, compared to the diversified S&P 500 which returned 11.2%.

Over a two year period, these stocks declined by 6.7% on average, compared to a decline of 7.5% for the S&P 500. Zooming out even farther though, they returned over 300% over the past five years, compared to 58% for the market!

Advantages of a concentrated portfolio:

  • Higher returns: A concentrated portfolio can lead to higher returns than common benchmarks like the S&P 500 if your selected stocks perform well.
  • Simpler management: Fewer stocks to track means easier portfolio management.

Disadvantages of a concentrated portfolio:

  • Increased risk: With all your eggs in one (or a few) baskets, getting it wrong on one stock could have significant consequences.
  • More volatility: You have to have a strong stomach, as a concentrated portfolio is generally more sensitive to market fluctuations. Just take a look at the whipsawed movements of Tesla (the dark blue line) in the chart.
  • Concentrated sector exposure: In this example, you’re putting all your chips on tech performing well.

Keep in mind, this is is a simplified scenario. To maintain consistent 20% exposure to each tech stock, you would need to buy and sell shares to rebalance.

The diversified portfolio

In contrast, an equally allocated portfolio to the five sectors mentioned above through five ETFs returned 5.6% over the past year, well below the concentrated portfolio’s return. However, over the past two years, this allocation declined 4.8%, compared to a decline of 5.6% for the concentrated portfolio.

In the below charts we show: Tech (XLK), Consumer Discretionary (XLY), Energy (XLE), Financials (XLF), and Real Estate (VNQ) in addition to the S&P 500 (SPY) and Nasdaq 100 (QQQ).

Advantages:

  • Lower risk: Spreading your investments lowers the risk of a significant loss.
  • Stable Returns: A diversified approach usually yields more consistent returns. You didn’t gain or lose as much as the concentrated portfolio over the past two years.
  • Multiple opportunities: Diversified exposure to different sectors can be very beneficial if one performs well. For example, with higher oil prices, energy (XLE) has been on a tear over the past two years. Without it, the diversified portfolio’s performance would have been worse than the concentrated portfolio.

Disadvantages:

  • Limited gains: Your gains are spread out, so a high-performing asset will have less impact.
  • Complex management: The more diversified, the more you'll need to monitor and manage your assets.

🛠️ How can Mezzi help?

Mezzi gives you insights currently reserved for those with expensive wealth advisors. Quickly see if you have a concentrated or diversified portfolio in terms of both individual holdings and sector allocation. If your top 10 holdings are approaching 100% of your portfolio, then you likely have a concentrated portfolio.

Similarly, if you have over 50% of your portfolio allocated to one sector, you probably also have a concentrated portfolio.