Should Every Part of Your Portfolio Have the Same Investment Objective?

Suppose you have $5 million invested. Does every dollar need to do the same job?

Some of that money may be there for liquidity and near-term spending. Some may fund retirement. Another portion may eventually go to your children. But if those needs are already well covered, could a smaller portion of your portfolio have a very different objective?

There is a simple idea behind this: different parts of your money can have different jobs.

This is sometimes called goals-based investing. Money you may need next year should probably be invested differently from money you may not need for 10 or 20 years. The same thinking can apply to different portions of your investment portfolio.

For example, once your important financial needs are adequately funded, you might decide that a smaller portion of your portfolio can pursue substantially greater growth while accepting substantially greater risk.

I sometimes think of this as a growth sleeve, or even an aspirational sleeve.

Why take the additional risk? Because the potential reward can also be substantially greater. Over a long enough period, higher returns can make an enormous difference through compounding, potentially multiplying the value of an investment several times over. Of course, greater growth potential comes with the possibility of significant losses along the way, and there is no guarantee that taking more risk will result in higher returns.

This is where risk capacity becomes just as important as risk tolerance.

Consider someone with a $5 million portfolio who puts $500,000 into a higher-risk strategy. If that investment falls 40%, the loss is $200,000. That's certainly painful, but assuming everything else is unchanged, it represents 4% of the overall portfolio.

Now consider someone with $500,000 in total investments who puts $200,000 into the same strategy. The same 40% decline costs $80,000, or 16% of everything they have invested.

Same strategy. Same decline. Very different financial consequences.

That's why I think the first question shouldn't simply be, “How much could I make?”

It should also be, “What happens to my life if this investment doesn't work the way I hope?”

Would a significant loss affect when you can retire? Would it change your lifestyle or interfere with another important financial goal? If so, that money probably shouldn't be taking substantial risk.

There is also an emotional side. Watching an investment fall substantially feels very different from checking the “high risk tolerance” box on a questionnaire. And if six disappointing months would cause you to abandon a long-term strategy, a highly volatile investment may simply be the wrong fit.

So no, every part of your portfolio doesn't necessarily need the same investment objective. But that doesn't mean everyone needs a high-risk portion either.

The important question is whether a portion of your wealth can reasonably have a different job.

And sometimes the best way to answer that question is to look at both sides:

What could this money become if things go well? And what happens to my life if they don't?