A beginner's guide to building a model long-term investment portfolio

Investing in the stock market is a powerful way to grow your wealth over time. As a retail investor, creating a well-diversified and balanced portfolio can help you achieve long-term financial goals. In this article, we will explore the basics of portfolio allocation, the importance of diversification and provide a step-by-step guide to building a model portfolio.

The Importance of Portfolio Allocation

Portfolio allocation is the process of dividing your investments among different asset classes, such as stocks, bonds, and cash. The goal is to create a mix of assets that can potentially optimise returns and reduce risk. A well-allocated portfolio can help you:

1. Reduce volatility: Diversifying your investments across various asset classes can help reduce the impact of market fluctuations on your portfolio.

2. Optimise returns: Different assets may perform well at different times, so a diversified portfolio can help increase the chances of achieving your long-term investment goals.

3. Manage risk: Spreading your investments across different assets can help protect your portfolio from the negative effects of a single asset or market event.

Step-by-Step Guide to Building a Model Portfolio

Step 1: Determine your investment goals and risk tolerance

Before you start building your portfolio, consider your financial goals and risk tolerance. 

Factors to consider include:

• Time horizon: How long do you plan to invest? Longer time horizons can accommodate more aggressive allocations.

• Risk tolerance: Are you comfortable with short-term fluctuations in your portfolio's value? If not, consider a more conservative allocation.

Step 2: Choose your asset classes

Select a mix of asset classes that align with your risk tolerance and investment goals. Common asset classes include:

• Stocks: Ownership in individual companies, providing potential for capital appreciation and dividend income.

• Bonds: Debt securities that provide income through interest payments.

• Cash or cash equivalents: Short-term, low-risk investments such as money market funds or certificates of deposit.

Step 3: Allocate your assets

Decide on the percentage of your portfolio that you will allocate to each asset class. 

Consider the following guidelines:

• For aggressive investors: 70-80% stocks, 20-30% bonds, 0-10% cash or cash equivalents.

• For moderate investors: 50-60% stocks, 30-40% bonds, 10-20% cash or cash equivalents.

• For conservative investors: 20-30% stocks, 50-60% bonds, 20-30% cash or cash equivalents.

Adjust these allocations as needed based on your personal risk tolerance and time horizon.

Step 4: Diversify within each asset class

To further reduce risk, diversify within each asset class by investing in a variety of individual securities or exchange-traded funds (ETFs). Consider the following strategies:

• For stocks: Invest in companies from different industries, sectors, and geographic regions.

• For bonds: Choose bonds with varying maturities, credit ratings, and issuers.

• For cash or cash equivalents: Spread your investments across multiple financial institutions or money market funds.

Step 5: Monitor and rebalance your portfolio

Regularly review your portfolio to ensure it remains aligned with your investment goals and risk tolerance. Rebalance your portfolio periodically by adjusting your allocations to maintain your desired asset mix.

Case Study Example: Hypothetical Model Portfolio for Moderate-Risk Singaporean Investor seeking Domestic, US, and Asian Market Exposure

Singapore-based retail investors looking for a diversified investment portfolio, it's essential to consider a mix of domestic, US, and Asian market exposure. This article will provide hypothetical model portfolios for aggressive, moderate, and conservative risk profiles. Please note that these examples are for illustrative purposes only and should not be considered specific investment advice.

Aggressive Risk Profile:

Equities (70%):

• 30% Singapore Blue Chip Stocks (e.g., DBS, Singtel, Keppel Corp)

• 20% Asia-Pacific Ex-Japan Equities (ETF or actively managed fund)

• 20% Global Equities (ETF or actively managed fund)

Bonds (20%):

• 10% Singapore Government Bonds (e.g., SGS Bonds, Singapore Savings Bonds)

• 10% International Corporate Bonds (ETF or actively managed fund)

Alternatives (10%):

• 5% Real Estate Investment Trusts (REITs)

• 5% Gold or other commodities (ETFs or physical)

Moderate Risk Profile:

Equities (50%):

• 20% Singapore Blue Chip Stocks (e.g., DBS, Singtel, Keppel Corp)

• 15% Asia-Pacific Ex-Japan Equities (ETF or actively managed fund)

• 15% Global Equities (ETF or actively managed fund)

Bonds (40%):

• 20% Singapore Government Bonds (e.g., SGS Bonds, Singapore Savings Bonds)

• 20% International Corporate Bonds (ETF or actively managed fund)

Alternatives (10%):

• 5% Real Estate Investment Trusts (REITs)

• 5% Gold or other commodities (ETFs or physical)

Conservative Risk Profile:

Equities (30%):

• 15% Singapore Blue Chip Stocks (e.g., DBS, Singtel, Keppel Corp)

• 7.5% Asia-Pacific Ex-Japan Equities (ETF or actively managed fund)

• 7.5% Global Equities (ETF or actively managed fund)

Bonds (60%):

• 30% Singapore Government Bonds (e.g., SGS Bonds, Singapore Savings Bonds)

• 30% International Corporate Bonds (ETF or actively managed fund)

Alternatives (10%):

• 5% Real Estate Investment Trusts (REITs)

• 5% Gold or other commodities (ETFs or physical)

Always consult with a financial professional before making any investment decisions, as individual circumstances and preferences may vary.


Hypothetical Portfolio Selection: 

Below are specific ETF suggestions for the aggressive, moderate, and conservative model portfolios using liquid and reputable ETFs. Please note that these examples are for illustrative purposes only and should not be considered specific investment advice.

Equities:

1. SPDR Straits Times Index ETF (ES3.SI) - Singapore Blue Chip Stocks

   • Top 3 Holdings: DBS Group, OCBC Bank, United Overseas Bank


2. iShares MSCI All Country Asia ex Japan ETF (AAXJ) - Asia-Pacific Ex-Japan Equities

   • Top 3 Holdings: Tencent Holdings, Taiwan Semiconductor Manufacturing, Alibaba Group Holding


3. Vanguard Total World Stock ETF (VT) - Global Equities

   • Top 3 Holdings: Apple, Microsoft, Amazon

Bonds:

1. ABF Singapore Bond Index Fund (A35.SI) - Singapore Government Bonds

   • Top 3 Holdings: Singapore Government Bonds maturing in 2026, 2029, 2030


2. iShares iBoxx $ Investment Grade Corporate Bond ETF (LQD) - International Corporate Bonds

   • Top 3 Holdings: Verizon Communications, Anheuser-Busch Inbev Finance, CVS Health

Alternatives:

1. iShares Global REIT ETF (REET) - Real Estate Investment Trusts

   • Top 3 Holdings: American Tower Corp, Prologis Inc, Crown Castle International


2. SPDR Gold Shares (GLD) - Gold and other commodities

   • Tracks the gold spot price, less expenses and liabilities, using gold bars held in London vaults

Conclusion

Building a well-allocated and diversified portfolio can help retail investors achieve long-term investment appreciation while managing risk. By following these steps, you can create a model portfolio that aligns with your financial goals and risk tolerance. Remember that investing is a long-term endeavour, and maintaining a disciplined approach is key to achieving success.

Supporting Studies and Rationale for Allocation

The chosen allocations are based on the following studies and considerations:

1. Domestic Market Bias: Studies have shown that investors tend to have a home bias, preferring to invest in their home country's stocks and bonds. This preference is often due to familiarity and perceived lower risk. For our Singaporean investor, allocating 40% to the domestic market can provide a comfort level while still maintaining diversification across other markets. A well-known paper on home bias is "Investor Diversification and International Equity Markets" by Kenneth R. French and James M. Poterba. (source ↗) 

2. US Market Exposure: The US market is the largest and most diversified in the world, representing a significant portion of global market capitalization. Research suggests that including US stocks and bonds in a portfolio can improve risk-adjusted returns. The importance of US market exposure is supported by various studies, including "A Disciplined Approach to Global Asset Allocation" by Robert D. Arnott and Roy D. Henriksson, Vol. 45, No. 2 (Mar. - Apr., 1989), pp. 17-28 (12 pages) (source ↗).

3. Asian Market Exposure: The Asian market, excluding Japan, has shown significant economic growth and potential for higher returns. By investing in a mix of developed and emerging Asian markets, our investor can gain exposure to this growth while managing risk through diversification. For information on the growth potential and diversification benefits of Asian markets, you can refer to the International Monetary Fund (IMF) publications and research papers on Asian economic growth and regional integration. (source ↗).

4. Stocks and Bonds Mix: A moderate risk portfolio typically includes a balanced mix of stocks and bonds. Studies have shown that a 50/40/10 mix of stocks, bonds, and cash can provide an optimal balance of risk and return for moderate-risk investors. One of the foundational studies on the importance of asset allocation is "Determinants of Portfolio Performance" by Gary P. Brinson, L. Randolph Hood, and Gilbert L. Beebower, published in the Financial Analysts Journal, vol. 42, no. 4, 1986, pp. 39–44. (source ↗).

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