Portfolio Management Tips for Young Investors

Wednesday, Aug 28, 2024

The current youngsters are supposedly one of the most knowledgeable bunch compared among the entire history of mankind. This is simply due to access to information. This concept never existed before and now—along with its existence—it's created a new generation of smart individuals with lightspeed access to the world's knowledge repertoire.

But how many among them actively make use of this? Turns out, not a lot. Because, while not having access at all would clearly be a barrier, having unlimited access is not without challenges as well. The sheer volume of information is overwhelming and sometimes contradictory—leading to decision paralysis or, worse, inaction.

Young investors today have access to a wealth of financial data, investment strategies, and market analyses that their predecessors could only dream of. Yet, many find themselves hesitating at the threshold of financial markets and are unsure and unaware of how to translate this abundance of information into actionable investment decisions.

This hesitation is understandable. The financial world is indeed complex and the stakes feel high when you're just starting to build your wealth. Traditional investment wisdom often feels outdated, boring and too slow —while the new investment vehicles and strategies are simply hard to comprehend, effectively understand–in order to build enough trust to make the investment.

That's where modern portfolio management comes in.

It's not just about picking stocks or bonds anymore; it's about knowing what your goals are, understanding the realities of today's markets, and what percentage of your capital are you comfortable seeing in the red—and with all that data—creating the perfect strategy that works for you.

In this article, we'll explore some of the cutting-edge portfolio management tips for the young investor of 2024. Our aim is not just to provide a roadmap for investment, but to enable you with the knowledge and confidence to take control of your financial future. In an age where information is abundant but clarity is rare, let's cut through the noise and focus on what truly matters in building a forward-looking investment portfolio.

Dynamic Risk-Parity Allocation

Ever heard of algorithms? Yes? That’s what we thought. Did you know that you can let them continually reiterate, revise and redefine your investment allocations, and maintain them at the precise level of your risk tolerance?

Dynamic risk-parity allocation is an investment strategy that automatically adjusts the proportion of different asset classes in your portfolio to maintain a consistent level of risk over time.

The first step is to assign a risk budget to each asset class in your holding.
Then, the algorithm continuously monitors the volatility of each individual asset.
When one of the asset becomes more volatile than anticipated, the allocation of the asset is reduced to maintain the same level of risk.
At the same time, it increases allocation to the assets with lower volatility.

Basically, this approach ensures that no single asset dominates the portfolio’s risk profile and introduces a force that continually stabilizes your portfolio.

This is particularly exciting for young investors because:

It’s hands off
It reinforces stability to the financial health score

Thematic ETFs

A thematic ETF primarily builds the central part of a portfolio around Exchange-Traded Funds (ETFs) focused on specific themes or trends shaping the future economy.

Here's how you make this work.

Start by recognizing major trends that will shape the future. These can be sectors like artificial intelligence, clean energy, cybersecurity etc.
Choose an ETFs that tracks companies involved in these themes. These ETFs group together stocks of multiple companies working in the same area.
Then, you allocate a significant portion of your portfolio to these thematic ETFs. Add individual stock picks or other assets by doing your own research. Doing so actually strengthens your thematic holdings.
It's crucial that you monitor and periodically assess if the chosen themes are still relevant and reiterate your portfolio composition.
Let's say you really believe in clean energy. Instead of trying to pick individual solar or wind companies, you can invest in a clean energy thematic ETF.

A hypothetical "FutureClean ETF" might consist of a distribution like this.

25% solar panel manufacturers
25% wind turbine companies
20% energy storage solutions
15% smart grid technology firms
15% green hydrogen producers

By investing in this single ETF, you gain exposure to the entire clean energy ecosystem. This lets you invest in what you believe in terms of the changes and adaptations in the world while also not increasing your risk exposure to a specific company within the niche. Instead, your risk is spread across multiple companies and sub-sectors within the theme.

Asymmetric Risk-Reward Investing

Asymmetric risk reward means, having upside potential of the reward outweighs the downward potential. The goal is to create a portfolio where: Potential Gain > Potential Loss

Ideally, the ratio should be heavily skewed towards gains. It would be awesome if the ‘Potential Gain = 3x to 10x (or more) of Potential Loss’ wouldn’t it?

That’s what Asymmetric Risk-Reward Investing is all about.

The investments will have no clear ceiling on potential gains that they will be able to make. Basically, you set clear maximum loss limits for each investment and use stop-loss orders or options strategies to enforce these limits.

So, how can these actually be implemented?

1. Long Calls

Buying Long Calls is one such approach. It is also simple. Since you would have already paid the premium to own the call, the downside is fixed. However, the upside potential of such a long call option will be unlimited. If the value of the asset/company you believe goes down, it might be due to random circumstances, but if a company is great, its value generally increases over time and when your long option matures, you will be able to make the upside.

2. Vertical Spreads

In this approach, you are essentially simultaneously buying and selling options of the same type with the same expiration date, but with different strike prices. The beauty of this strategy lies in its ability to define both your maximum potential loss and your maximum potential gain right from the start.

For instance, in a Bull Call Spread, you buy a call option at a lower strike price and simultaneously sell a call option at a higher strike price. The premium you get from selling the higher strike call partially offsets the cost of the lower strike call you bought. This reduces your initial outlay and, consequently, your maximum potential loss.

But the trade-off is that even your potential gain is capped. The key here is that you're often able to structure the spread so that your potential gain significantly outweighs your potential loss. For example, you might risk INR 10,000 to potentially make INR 40,000 - a 4:1 reward-to-risk ratio.

If the underlying asset's price increases beyond both strike prices by expiration, you'll achieve your maximum profit. If it falls below both strike prices, you'll incur your maximum loss. This is limited to the net premium paid. This is what makes Vertical Spreads a very strategic mode for anyone seeking downside protected asymmetric investment opportunities.

While these are sound approaches, here are some tips before you start out:

Start with paper trading to practice without risk
Allocate only a small portion of your portfolio to this strategy initially
Keep detailed records of all trades and their rationales
Continuously educate yourself on market dynamics and new opportunities
Network with other asymmetric investors to share ideas and strategies
Regularly review and adjust your approach based on results and changing market conditions

Venture Capital Approach

Discovering the next big thing before everyone else. That's what venture capitalists do for a living. While most of their bets are wrong, when they do bet on the winning start-up, they win massively. It offsets all of their losses and makes them 10x, 100x, or once in a blue moon a 1000x return .

Well, you too can apply the VC strategy to your own investment portfolio! So, how does this work in practice? Glad you asked!

Instead of putting all your eggs in one basket, you scatter them across multiple promising startups.
What kind of businesses are we talking about? No, not ketchup or chocolate; we're talking cutting-edge tech, revolutionary services, things that might seem like science fiction today.
Patience is key here. You're not looking for overnight success, but for ideas that could reshape entire industries over years or decades.
Here's the tough part - many of these investments will fail. But remember, you only need one to massively succeed, offsetting the rest of the losses.
The asymmetric angle? Your potential gains can be exponentially larger than your potential losses. We're talking 10x, 100x, or even 1000x returns on the winners.

Now, you might be thinking, "Sounds great, but isn't this just for the big players?" Not necessarily! Thanks to equity crowdfunding platforms and angel investing networks, even individual investors can utilise this approach and have access to make such investments.

This investment strategy actually only makes sense for young investors. Why is that?

It's a chance to be part of something big from the ground up.
It aligns perfectly with the long time horizon young investors have.
It's a way to turbocharge your returns, albeit with higher risk.

Barbell Strategy

While we’re not sure if the name justifies the investment strategy, but we’ll tell you how it works and you can decide that on your own. When you see Barbell at the gym, what do you see? Two heavy weights on either end of a bar, right? Now, let's translate that image into your investment portfolio:

On one end: Ultra-safe investments. Think government bonds, high-yield savings accounts, or stable blue-chip stocks.

On the other end: High-risk, high-reward opportunities. We're talking about cutting-edge tech startups, cryptocurrencies, or emerging market stocks.

And in the middle? Nothing.

Sounds crazy? Here's why it's not:

The safe end: This is your financial safety net. It's there to preserve your capital and let you sleep soundly at night.
The risky end: This is your ticket to potentially explosive gains. It's your chance to catch the next big wave before it crests.
The empty middle: By avoiding middle-of-the-road investments, you're steering clear of assets that might not offer enough reward to justify their risk.

So, how do you balance this barbell?

Typically, you'd put about 80-90% of your portfolio in the safe stuff. The remaining 10-20%? That's your "crazy money" for high-risk plays.

This mode of investing is particularly exciting because;

It's the best of both worlds: You're playing it safe AND taking big swings.
It's flexible: As you age or your situation changes, you can easily adjust the balance.
It's psychologically satisfying: You can take risks knowing most of your money is secure.

Liquidity Tiering

Of course you know what liquidity refers to in finance. How easy is it to cash out of your investment? The easier it is, the more liquid the investment. Taking the funds out of your savings account is one the most liquid investments. So, what does the tiering refer to? Yes, like the cake, it does refer to supposed “layers”.

So, what's the deal with these financial layers?

Layer 1

The Quick-Access Reserve: This is your emergency fund. Think cash, high-yield savings accounts, or money market funds. It's not the most exciting part of your portfolio, but it's there when you need it most.

Layer 2

The Flexible Investments: This is where you might allocate ETFs, blue-chip stocks, or government bonds. These assets aren't as liquid as Layer 1 but can be accessed when necessary.

Layer 3

The Long-Term Assets: This layer includes real estate, private equity, or even alternative investments like a vintage wine collection. These assets aren't easy to cash out quickly, but the potential returns can be substantial.

Why bother with all these layers?

Each layer has its own place and purpose.
You can optimize returns while ensuring you have cash available when needed.
Tapping into the 'illiquidity premium' can potentially lead to higher returns from investments that are harder to exit quickly.

From the POV of young investors’, this strategy teaches patience. It encourages you to resist the urge to liquidate long-term investments for short-term needs. It also adapts over time–allowing you to allocate more to higher-yield, less liquid assets as your wealth grows. Finally, it safeguards you without you knowing. It makes you less likely to make impulsive decisions with your long-term investments.

The Fundamentals.

Build an emergency fund covering 3-6 months of expenses. This is your first tier in liquidity tiering.
Create and stick to a budget. It's the foundation for all your investment strategies.
Pay off high-interest debt first. It's often the best "investment" you can make.
Diversify your investments across asset classes, sectors, and geographies.
Continuously educate yourself about finance and investing. It's key to identifying asymmetric opportunities.
Start investing early and consistently. Time in the market beats timing the market.
Live below your means. The difference is your capital for future investments.
Automate your savings and investments. Set it and forget it, like algorithmic trading for your savings.
Regularly review and rebalance your portfolio. It's the manual version of dynamic risk-parity allocation.
Don't neglect insurance. It's a form of asymmetric risk management for your life.
Maximize tax-advantaged accounts before exploring taxable investments.
Be patient with illiquid investments.
Keep an eye on fees. They can eat into your returns, especially in long-term, compound-growth scenarios.
Develop multiple income streams.
Have clear financial goals.
Don't try to keep up with what’s hot on instagram. Focus on your own financial journey.
Learn to distinguish between needs and wants. It'll help you allocate resources more effectively.
Build a network of financially savvy peers. They're your personal board of advisors.

Remember: No investment strategy replaces the need for adequate income and prudent spending.

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