The idea of a minimalist lifestyle and the desire to declutter our busy lives led to the capsule wardrobe idea. This idea is all about building a simple, structured closet with a small number of pieces all compatible with your style and lifestyle.
This is exactly what you want from your investment portfolio. Simplicity and congruence with your goals, your investing time frame and your risk tolerance.
So how do you create this “capsule investing portfolio”
Begin by getting clear on what you want from your capsule portfolio
Similarly to creating your capsule wardrobe your capsule portfolio is personal to you. As such you should have a clear idea of what goals you want your portfolio to achieve, the time horizon for those goals and the level of risk you are comfortable taking to achieve your goals.
Your goals are most likely to be a combination of short term goals, being those you want to achieve in less than 5 years, moderate to long term goals, being those beyond 5 years and life time goals most likely being your retirement goals.
Once you understand where your goals are on the timeline you can plan your portfolio appropriately. Your retirement goals are most effectively met inside the tax efficient vehicle of a pension. The medium too long term goals would be suitable within a tax wrapper, such as an ISA in the UK or alternatively in a taxable general investment account.
Start from your foundation and work upwards
At the foundation you want your safer assets, such as your savings accounts. One such saving account should house your emergency fund, being, as a general rule of thumb, enough cash to cover 3 to 6 month of basic necessities. Other savings accounts would be for those goals you want to achieve in less than 5 years.
Investing in the market is volatile and this should be reserved for goals greater than 5 years to ensure your investments have enough time to ride out the dips in the market.
The centre of your plan is your core portfolio. The core portfolio should be simple, easy to maintain and effective. And for this I enthusiastically recommend choosing funds and in particular passive ones, as these are relatively cheap not having to carry the cost of an expensive fund manager, easy and give instant diversification.
The cherry on top of your plan is where you will add your more speculative investments such as individual shares, commodities such as gold, bitcoin and collectibles such as art.
Plan your core capsule portfolio
An effective capsule portfolio contains a mix of different asset classes which are investments having diverse risk profiles. This ensures your portfolio can provide a reasonable return through different market cycles as the various investments will perform differently in these cycles, with a drop in one offset by a rise or stability in another.
The allocations across the different asset classes will be driven by the return you are targeting as well as the degree of risk you are comfortable with.
The logic behind the allocation is the higher the equity allocation, the higher the return and the higher the risk. The higher the bond allocation, the lower the return and the lower the risk.
A back of the envelope allocation between equity and bonds might be to assume the allocation to bonds equivalent to your age and adjust as follows:
Aggressive risk tolerance: Decrease the bond allocation by 20%
Growth risk tolerance: Decrease the bond allocation by 10%
Balanced risk tolerance: Don’t change the bond allocation
Cautious risk tolerance: Increase the bond allocation by 10%
Conservative risk tolerance: Increase the bond allocation by 20%
The timeline until you will require your portfolio to meet your goals will also influence the investment allocation. The longer the timeline the higher the risk the portfolio can be exposed to because as mentioned before you have the runway to ride out the market drops.
Building out the core of your capsule portfolio
This is the part where you get to shop for the investments within the different asset classes.
The objective is to keep it simple, all-weather, in that it is diversified across different geographies and industries and easy to manage.
And for this I would suggest starting with two funds held in proportion to the level of risk tolerance you are comfortable with.
A global equity fund
A global bond fund
Over time as you gain confidence with investing you can add exposure to emerging market equities, domestic small cap funds and global property funds. All of which will reduce the allocation to the global equity fund which will however still remain the core equity fund in your portfolio.
Add the accessories to your capsule portfolio
As your investing confidence grows, look to add the adornments. These are the assets that can add that little bit of fun to the portfolio.
They are the higher risk, more speculative parts of your portfolio and may include commodities like gold, cryptocurrencies for example bitcoin, collectibles such as art and individual shares.
And because they are the more racy part of your capsule portfolio, less is more on these types of investments.