Chapter 4: Portfolio Construction
Recap
Here's a recap of your explanation on asset allocation:
How you allocate your assets significantly affects the risk and potential returns of your portfolio. Asset allocation is a key strategy for balancing risk and reward while continuing to invest in the same companies.
For example, if you're satisfied with holding five stocks but believe that adding more could hinder your ability to outperform the market, you can still adjust your risk level by reallocating within those stocks. To make your portfolio safer, you could increase the allocation to one of your safer stocks and reduce the allocation to some of your riskier stocks. This way, the safer stock will have a larger impact on your portfolio, minimizing the influence of the riskier ones.
In the event that one of the risky stocks were to drop by 50%, your portfolio would experience less overall loss due to this strategic reallocation.
The next step
The next step in asset allocation is to allocate based on the time you spend researching different stocks. For example, if you really like to follow one stock and invest a lot of time into making a well-informed decision, you might consider allocating more money toward it. On the other hand, you should probably allocate less money to a stock that you don't pay much attention to.
Low and high attention stocks
The best approach here is to create a system where you categorize your stocks into low-attention, medium-attention, and high-attention groups. High-attention stocks are those you spend more time researching and tracking, so it makes sense to allocate slightly more of your portfolio to them. However, it's important not to overdo it. A good guideline is to allocate an extra 4-5% of your portfolio to these high-attention stocks while maintaining balance across the other categories. This method allows you to align your investment strategy with the level of attention and research you give to each stock, without taking on excessive risk.