10 Minute Read

Options Theory: Best Practices for Building a Diversified Portfolio

July 1, 2021

By | No Comments

The first meeting of Team Phoenix is in the books and I’m delighted by the foundation we laid. One of the requests I received was to talk about the best practices for building a diversified portfolio. I will share some ideas in today’s blog.

The first thing to decide is whether we’re talking about a long-term passive portfolio or a trading account. For instance, I use one of my Roth IRAs as a passive portfolio. I dollar cost average into a basket of ETFs every year. Each fund represents a category I want ongoing exposure to. The aim is to get high single digit annual returns, or whatever the financial markets end up giving.

The current categories I use aren’t unique. I suspect anyone who has a properly diversified stock-centric portfolio uses them:

  • U.S. large cap
  • U.S. mid cap
  • U.S. small-cap
  • Foreign Developed
  • Emerging Markets
  • Real Estate

I don’t own bonds in this account for multiple reasons.

One: I’m young and have a multi-decade time horizon. Stocks beat the pants off bonds over the long run, especially when starting from such a low-interest rate. I have time to hold through any bear markets that come my way.

Two: I’m comfortable with the volatility that accompanies an all-stock portfolio. I know that my account will experience 10% drawdowns once a year on average and 30%+ drawdowns once every five years or so. They will be temporary and serve as great buying opportunities.

Three: My investment objective for this account is to grow my assets as much as possible. Historically, the stock market does this better than any other asset class, including bonds.

Asset Allocation

iShares Core ETFs.

I left the decision of how much to allocate to each sleeve up to an entity far smarter than me: BlackRock. In case you didn’t know, BlackRock is the world’s largest asset manager. They are the provider of many ETFs, including the “iShares” line.

They have a portfolio builder tool with built-in suggestions for portfolio allocations. You can choose how aggressive or conservative you want to be, and they’ll give you a preset mix.

I suspect they use valuation metrics as part of their decision-making. Currently, their allocation to foreign stocks (like IEFA and IEMG) is higher due to the lower P/E ratios. In other words, foreign stocks trade at lower valuations than their U.S. counterparts. To capitalize on this, BlackRock is suggesting to overweight your overseas exposure.

I’ll hasten to add that I don’t think it matters all that much in the long run. Not panicking during crashes, continuing to invest every year, using low-cost ETFs, and owning stocks over bonds or cash, is what will make the biggest difference in the long run. Whether you’re 30% in foreign stocks and 70% in U.S., or some other variation matters far less.

That provides a brief introduction to how I think about diversifying a long-term passive account. Next time I’ll dig into doing so with an active trading account.

Read more Options Theory [FREE Content]

Every Thursday our resident options addict, Tyler Craig, will be at the helm to help you demystify derivatives and better understand what truly makes them tick. Options for beginners? Come this way, please. Enlightenment awaits.

Tackle Trading: Financial Freedom is a Journey. Sign up now for a 15-day free trial.

Financial freedom is a journey

Sign up now and gain unfettered access to all of the quality content and powerful Scouting Reports that our Pro Members enjoy for 15-days absolutely free with no strings attached and let us show you what your trading has been missing.

Legal Disclaimer

Tackle Trading LLC (“Tackle Trading”) is providing this website and any related materials, including newsletters, blog posts, videos, social media postings and any other communications (collectively, the “Materials”) on an “as-is” basis. This means that although Tackle Trading strives to make the information accurate, thorough and current, neither Tackle Trading nor the author(s) of the Materials or the moderators guarantee or warrant the Materials or accept liability for any damage, loss or expense arising from the use of the Materials, whether based in tort, contract, or otherwise. Tackle Trading is providing the Materials for educational purposes only. We are not providing legal, accounting, or financial advisory services, and this is not a solicitation or recommendation to buy or sell any stocks, options, or other financial instruments or investments. Examples that address specific assets, stocks, options or other financial instrument transactions are for illustrative purposes only and are not intended to represent specific trades or transactions that we have conducted. In fact, for the purpose of illustration, we may use examples that are different from or contrary to transactions we have conducted or positions we hold. Furthermore, this website and any information or training herein are not intended as a solicitation for any future relationship, business or otherwise, between the users and the moderators. No express or implied warranties are being made with respect to these services and products. By using the Materials, each user agrees to indemnify and hold Tackle Trading harmless from all losses, expenses and costs, including reasonable attorneys’ fees, arising out of or resulting from user’s use of the Materials. In no event shall Tackle Trading or the author(s) or moderators be liable for any direct, special, consequential or incidental damages arising out of or related to the Materials. If this limitation on damages is not enforceable in some states, the total amount of Tackle Trading’s liability to the user or others shall not exceed the amount paid by the user for such Materials.

All investing and trading in the securities market involves a high degree of risk. Any decisions to place trades in the financial markets, including trading in stocks, options or other financial instruments, is a personal decision that should only be made after conducting thorough independent research, including a personal risk and financial assessment, and prior consultation with the user’s investment, legal, tax and accounting advisers, to determine whether such trading or investment is appropriate for that user.

Chart Modal

Tackle Trading

Book a FREE Consultation

Sign up for a free consultation to build your Educational Plan.