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My thoughts on risk and reward

Updated: Feb 8, 2021

I occasionally get asked why I have so many different portfolios and asset streams. I thought I'd take some time to explain my strategy.

A venture portfolio, large cap growth portfolio, mid cap growth, investments in index funds, property? Why have so many different asset classes and so many income streams?.

It's something that I've taken some time to reflect on myself.

Ultimately, I think of my portfolio as a series of concentric circles, that represent progressive degrees of risk and reward. At the core of the portfolio is a chunk of assets in an index fund which represents close to 30% of our wealth, and the least amount of long term risk.

These assets are socked away in the S&P 500, which gets regularly rebalanced and readjusted based on the relative performance of the underlying components. Its arguably the least amount of risk because the index will never fail. The market reweighting of the individual components based on short and long term performance weeds out the underperformers and rewards the performers. And with so many companies in the index, the failure of a couple of components won't have a disastrous effect on the performance of the index.

Our index holdings are the lowest risk components of our overall portfolio for the reasons that I've mentioned above. Accordingly, I expect them to only produce a modest long term return. Nonetheless, I expect this will be a satisfactory return for me. Of course, I'm keen to get to financial independence as soon as possible. So I want to push my search for financial return a little further beyond just vanilla index funds.

This leads to the next outer ring of my portfolio, which is a selection of individually chosen large cap growth stocks, some of which coincidentally happen to pay dividends. These are above average performers that I've chosen because their returns on invested capital are higher than average.

They also have better than average growth prospects and good business stability that comes from years of brand building. The list of these stocks include companies like Visa, Mastercard, Alphabet, Adobe, Salesforce, Facebook and Service Now.

I expect these businesses to perform better than an index over time because of their superior characteristics. I could be wrong on this however.

The next concentric circle in my portfolio are emerging growth leaders. These businesses are an inherently more risky proposition because they are trying to create new markets or are in the midst of turnaround situations or have company specific risk.

Something like a Guardant Health has immense potential to revolutionize the ways cancer is tested and detected via blood tests. A business like Schrodinger is transforming how drug development is taking place.

The potential pay off from emerging portfolio is significant. However the risk in the portfolio is large. I have invested fewer investment dollars in this category, however they have rallied very hard through 2020 and now account for significant value.

The final outermost concentric ring in my portfolio is a collection of assets that are much earlier in maturity. They are not established businesses, but they have significant potential given some of the things that they are doing and the areas that they are focused on - The creation of new markets for the delivery of insurance, new technologies for ultrasound sterilization, and innovations for radiology digitization.

These are businesses that have potential to transform the world. If they are successful, they will lead to significant wealth creation. But they are much higher risk, precisely because they aren't established. I've seen enough glimmers of light in these businesses that I'm comfortable tying up some of my assets here. No doubt though, they carry higher risk in the establishment of their moats.

Portfolio allocation to me is a set of actions that extend my potential investment return. Each ring represents a new frontier as far as potential returns and also incremental risk in my assets.

Ultimately its an individual decision about how far one chooses to extend their comfort zone, but having an awareness of what you are doing and what the implications are is critical to ensuring success. In my case, I would argue owning the market through an index like the S&P500, has limited downside, and allowed me to be more aggressive with my active portfolio, with very good results.

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