Professional financial advisors prescribe diversifying one's investment portfolio across multiple asset classes. This means spreading your investments into each of the four major asset classes- stocks, bonds, real estate, and commodities. In theory, this helps to smoothen returns and reduces the "risk" in the portfolio.
So having a portfolio that is composed entirely of stocks is unconventional, to say the least. However, before you close this article and call me a nut job, let me explain the reasoning behind my asset-allocation strategy.
STOCKS: THE BEST-PERFORMING ASSET CLASS
Stocks are unlike any asset class. Eddy Elfenbein, portfolio manager of the AdvisorShares Focused Equity ETF, explains in his blog:
"All other assets are things. They just sit there. If you buy some gold and leave it alone, in 50 years it will still be there, just sitting there. There are income-producing assets like bonds and real estate, which makes them a little better than commodities. But still, they're just things. They can neither think nor create.
Equity, on the other hand, is wholly different. It's a legal entity by which people can come together and employ said assets to make goods and services for people… The business works to make a profit, and it keeps investing those profits in the business to make still more profits."
When you invest in stocks, you are really investing in the power of human ingenuity.
It is, therefore, not surprising to note that over the long term, stocks are by far the top-performing asset class. In fact, according to data from the University of Chicago, in the 100 years from 1915 to 2014, stocks had an average real return (after removing inflation) of 8.3 per cent per year, while bonds returned just 1.1 per cent per year.
A $1000 investment in bonds in 1915 would have a "real worth" of $2,992 in 2014, while $1000 invested in stocks would have been worth $2,301,134.
Other studies also consistently show that over the long-term stocks always come up on top, followed by bonds, real estate, and commodities.
THE POWER OF TIME
But performance alone is not the only reason to invest solely in stocks. I also need to be able to ride out the inevitable market swings in the stock market.
Thankfully, I have time on my side. As a young investor, I have the holding power to see out the downturns of the market. I do not foresee needing the money from my investments anytime soon, nor do I depend on cash flow from my investments.
On top of that, my investment objective is really to grow my retirement fund as fast as possible, rather than simply preserving wealth. This makes stocks the ideal investment asset for me.
I can also still be sufficiently-diversified even if I solely invest in stocks. Investing in a range of different companies that operate in different geographies and sectors help to diversify my risk. I can even gain exposure to real estate, by investing in real estate investment trusts (REITs), which are also traded on stock markets.
BUILDING YOUR PORTFOLIO
Legendary investor, Peter Lynch, once said, "Gentlemen who prefer bonds don't know what they're missing."
If you are a young investor and have a long investment horizon like I do, having a more aggressive investment portfolio might be the right way to go. However, investing solely in stocks does come with caveats. Investors need to be able to stomach inevitable market swings and steep drawdowns.
Having a disciplined long-term approach and sticking to your principles is key to success in the market.
Over the long-term, I take heart that despite the volatile nature of stocks, if history is anything to go by, my stock-heavy portfolio will likely provide better returns than if I diversify across multiple other asset classes.
This article was first published on The Good Investors. All content is displayed for general information purposes only and does not constitute professional financial advice.