Portfolios And Diversification

It's good to clarify how securities are different from each other, but it's even more important to understand how their different characteristics can work together to accomplish an objective. 

The Portfolio 
A portfolio is a combination of different investment assets mixed and matched for the purpose of achieving an investor's goal(s). Items that are considered a part of your portfolio can include any asset you own - from real items such as art and real estate, to equities, fixed-income instruments and their cash and equivalents. For the purpose of this section, we will focus on the most liquid asset types: equities, fixed-income securities andcash and equivalents. 

An easy way to think of a portfolio is to imagine a pie chart, whose portions each represent a type of vehicle to which you have allocated a certain portion of your whole investment. The asset mix you choose according to your aims and strategy will determine the risk and expected return of your portfolio. 

Basic Types of Portfolios 
In general, aggressive investment strategies - those that shoot for the highest possible return - are most appropriate for investors who, for the sake of this potential high return, have a high risk tolerance (can stomach wide fluctuations in value) and a longer time horizon. Aggressive portfolios generally have a higher investment in equities. 

The conservative investment strategies, which put safety at a high priority, are most appropriate for investors who are risk averse and have a shorter time horizon. Conservative portfolios will generally consist mainly of cash and cash equivalents, or high-quality fixed-income instruments. 

To demonstrate the types of allocations that are suitable for these strategies, we'll look at samples of both a conservative and a moderately aggressive portfolio. 

Note that the terms cash and the money market refer to any short-term, fixed-income investment. Money in a savings account and a certificate of deposit (CD), which pays a bit higher interest, are examples. 


The main goal of a conservative portfolio strategy is to maintain the real value of the portfolio, or to protect the value of the portfolio against inflation. The portfolio you see here would yield a high amount of current income from the bonds and would also yield long-term capital growth potential from the investment in high quality equities. 

A moderately aggressive portfolio is meant for individuals with a longer time horizon and an average risk tolerance. Investors who find these types of portfolios attractive are seeking to balance the amount of risk and return contained within the fund. 

The portfolio would consist of approximately 50-55% equities, 35-40% bonds, 5-10% cash and equivalents. 


You can further break down the above asset classes into subclasses, which also have different risks and potential returns. For example, an investor might divide the equity portion between large companies, small companies and international firms. The bond portion might be allocated between those that are short-term and long-term, government versus corporate debt, and so forth. More advanced investors might also have some of the alternative assets such as options and futures in the mix. As you can see, the number of possible asset allocations is practically unlimited. 

Why Portfolios? 
It all centres around diversification. Different securities perform differently at any point in time, so with a mix of asset types, your entire portfolio does not suffer the impact of a decline of any one security. When your stocks go down, you may still have the stability of the bonds in your portfolio. 

There have been all sorts of academic studies and formulas that demonstrate why diversification is important, but it's really just the simple practice of "not putting all your eggs in one basket." If you spread your investments across various types of assets and markets, you'll reduce the risk of catastrophic financial losses. 

How Stocks Trade

Most stocks are traded on exchanges, which are places where buyers and sellers meet and decide on a price. Some exchanges are physical locations where transactions are carried out on a trading floor. You've probably seen pictures of a trading floor, in which traders are wildly throwing their arms up, waving, yelling, and signaling to each other. The other type of exchange is virtual, composed of a network of computers where trades are made electronically.

The purpose of a stock market is to facilitate the exchange of securities between buyers and sellers, reducing the risks of investing. Just imagine how difficult it would be to sell shares if you had to call around the neighborhood trying to find a buyer. Really, a stock market is nothing more than a super-sophisticated farmers' market linking buyers and sellers.

Before we go on, we should distinguish between the primary market and the secondary market. The primary market is where securities are created (by means of an IPO) while, in the secondary market, investors trade previously-issued securities without the involvement of the issuing-companies. The secondary market is what people are referring to when they talk about the stock market. It is important to understand that the trading of a company's stock does not directly involve that company.

The New York Stock Exchange 
The most prestigious exchange in the world is the New York Stock Exchange (NYSE). The "Big Board" was founded over 200 years ago in 1792 with the signing of the Buttonwood Agreement by 24 New York City stockbrokers and merchants. Currently the NYSE, with stocks like General Electric, McDonald's, Citigroup, Coca-Cola, Gillette and Wal-mart, is the market of choice for the largest companies in America.


The NYSE is the first type of exchange (as we referred to above), where much of the trading is done face-to-face on a trading floor. This is also referred to as a listed exchange. Orders come in through brokerage firms that are members of the exchange and flow down to floor brokers who go to a specific spot on the floor where the stock trades. At this location, known as the trading post, there is a specific person known as the specialist whose job is to match buyers and sellers. Prices are determined using an auction method: the current price is the highest amount any buyer is willing to pay and the lowest price at which someone is willing to sell. Once a trade has been made, the details are sent back to the brokerage firm, who then notifies the investor who placed the order. Although there is human contact in this process, don't think that the NYSE is still in the stone age: computers play a huge role in the process.


The Nasdaq 
The second type of exchange is the virtual sort called an over-the-counter (OTC) market, of which the Nasdaq is the most popular. These markets have no central location or floor brokers whatsoever. Trading is done through a computer and telecommunications network of dealers. It used to be that the largest companies were listed only on the NYSE while all other second tier stocks traded on the other exchanges. The tech boom of the late '90s changed all this; now the Nasdaq is home to several big technology companies such as Microsoft, Cisco, Intel, Dell and Oracle. This has resulted in the Nasdaq becoming a serious competitor to the NYSE.

On the Nasdaq brokerages act as market makers for various stocks. A market maker provides continuous bid and ask prices within a prescribed percentage spread for shares for which they are designated to make a market. They may match up buyers and sellers directly but usually they will maintain an inventory of shares to meet demands of investors.

Other Exchanges 
The third largest exchange in the U.S. is the American Stock Exchange (AMEX). The AMEX used to be an alternative to the NYSE, but that role has since been filled by the Nasdaq. In fact, the National Association of Securities Dealers (NASD), which is the parent of Nasdaq, bought the AMEX in 1998. Almost all trading now on the AMEX is in small-cap stocks and derivatives.

There are many stock exchanges located in just about every country around the world. American markets are undoubtedly the largest, but they still represent only a fraction of total investment around the globe. The two other main financial hubs are London, home of the London Stock Exchange, and Hong Kong, home of the Hong Kong Stock Exchange. The last place worth mentioning is the over-the-counter bulletin board (OTCBB). The Nasdaq is an over-the-counter market, but the term commonly refers to small public companies that don't meet the listing requirements of any of the regulated markets, including the Nasdaq. The OTCBB is home to penny stocks because there is little to no regulation. This makes investing in an OTCBB stock very risky.

Types Of Investments

Bonds 

Grouped under the general category called fixed-income securities, the term bond is commonly used to refer to any securities that are founded on debt. When you purchase a bond, you are lending out your money to a company or government. In return, they agree to give you interest on your money and eventually pay you back the amount you lent out. 

The main attraction of bonds is their relative safety. If you are buying bonds from a stable government, your investment is virtually guaranteed, or risk-free. The safety and stability, however, come at a cost. Because there is little risk, there is little potential return. As a result, the rate of return on bonds is generally lower than other securities. 

Stocks 

When you purchase stocks, or equities, as your advisor might put it, you become a part owner of the business. This entitles you to vote at the shareholders' meeting and allows you to receive any profits that the company allocates to its owners. These profits are referred to as dividends. 

While bonds provide a steady stream of income, stocks are volatile. That is, they fluctuate in value on a daily basis. When you buy a stock, you aren't guaranteed anything. Many stocks don't even pay dividends, in which case, the only way that you can make money is if the stock increases in value - which might not happen. 

Compared to bonds, stocks provide relatively high potential returns. Of course, there is a price for this potential: you must assume the risk of losing some or all of your investment. 

Mutual Funds 

A mutual fund is a collection of stocks and bonds. When you buy a mutual fund, you are pooling your money with a number of other investors, which enables you (as part of a group) to pay a professional manager to select specific securities for you. Mutual funds are all set up with a specific strategy in mind, and their distinct focus can be nearly anything:large stocks, small stocks, bonds from governments, bonds from companies, stocks and bonds, stocks in certain industries, stocks in certain countries, etc. 

The primary advantage of a mutual fund is that you can invest your money without the time or the experience that are often needed to choose a sound investment. Theoretically, you should get a better return by giving your money to a professional than you would if you were to choose investments yourself. In reality, there are some aspects about mutual funds that you should be aware of before choosing them, but we won't discuss them here. 

Alternative Investments: Options, Futures, FOREX, Gold, Real Estate, Etc. 

So, you now know about the two basic securities: equity and debt, better known as stocks and bonds. While many (if not most) investments fall into one of these two categories, there are numerous alternative vehicles, which represent the most complicated types of securities and investing strategies. 

The good news is that you probably don't need to worry about alternative investments at the start of your investing career. They are generally high-risk/high-reward securities that are much more speculative than plain old stocks and bonds. Yes, there is the opportunity for big profits, but they require some specialized knowledge. So if you don't know what you are doing, you could get yourself into a lot of trouble. Experts and professionals generally agree that new investors should focus on building a financial foundation before speculating.

Trading Stocks Is Beneficial For Investors

As active traders we interact with Wall Street on a regular basis, so we've become accustomed to the ever-changing personalities of the stock market. As challenging as online stock trading may be sometimes, we're fortunate to know the "real" Street - that gritty pavement zone where the rubber meets the road.

This view is in contrast to the average investor who usually has a rather naive impression of how things work. Investors typically only have contact with the stock market once or twice a year. Though they may not know it, relying on casual or occasional oversight of one's stock holdings is not the best route to take.

As a rule the only person who really cares about your finances is you. There may be some rare exceptions, but in the stock market it usually isn't a good idea for investors to delegate fiscal responsibility to someone else.

Proactive stock market trading causes a person to develop skills and learn quickly. Successful stock traders know that a good education is essential. Though many investors are in denial about their limited abilities, many others have developed skills to take advantage of a constantly changing stock market. This trend toward intelligent trading appeals to investors who want to be more capable.

In spite of being viewed as river-boat gamblers, professional stock traders are generally regimented and highly skilled. This combination of discipline and expertise comes from the constant repetition involved in actively trading stocks. There's no substitute for the knowledge gained from realtime market interaction. Trading is a fast teacher, compressing decades of "normal" investing experience into just a few years. 

Long-term investors sometimes look at the short-term aspects of resources like the RightLine Report and immediately assume that the recommended strategies don't apply to them. In fact, even with the obvious differences in time frame, all of the basic principles of intelligent short-term trading apply to long term investing as well.

Such as . . .

- Detailed Planning - Ask the average investor to show you his or her investment plan and you'll probably get sidestepped. In fact, most investors don't have a real plan.

- Technical Analysis - Regardless of any other reason to buy a stock, the charts should always be used for timing entries. Support and resistance has a huge impact on stock price movement.

- Risk management - Investors rarely use proper position sizing techniques before buying. This means they are over-exposed to risk immediately after a purchase, and often take damaging losses before they even realize what has happened. Choosing the optimum number of shares to buy in relation to personal account size provides a layer of protection every investor needs.

- Trade management - This is where the rubber meets the road. Just looking at a monthly statement once a quarter rarely works in the real world of investing. Every investor should review their portfolio at regular intervals, and use trailing stops as part of their exit strategy. It's important to know when to get in, but when it comes to making money in the stock market, knowing where to get out is worth even more.

Bottom Line: In reality short-term trading is an efficient way to learn how to invest. Contrary to public opinion, trading is also more productive and much safer than investing - especially the way most folks invest.

Intelligent traders use proven market principles that work in any time frame. My associates and friends who just "invest" in the stock market are usually surprised to discover that the GCM and website is very relevant to their situation - even if they don't "trade". As GCM been awards as WORLD FINANACE FOREIGN EXCHANGE AWARDS 2013 Best Retail Trading Platform.

      

Invest well!