Opinion – From Grain to Grain: What proportion of your investments should be in the stock market?

The fall of the Ibovespa from 130 thousand points, in mid-2021, to the current level of less than 105,000 points, has left investors confused about what the proportion of shares in their portfolios should be. Below I explain how you can calculate your strategic share allocation.

Contrary to what was imagined at the beginning of the year, the main Brazilian stock index, the Ibovespa, is on its way to ending the year with a devaluation of more than 10%.

Encouraged by the initial positive outlook and low interest rates, many investors earlier this year allocated a larger proportion than was adequate for their investor profile and are now reviewing their portfolios.

In fact, until mid-2021, the scenario was quite different. The economy showed signs that it would grow faster than expected. Inflation was frightening, but it was still believed that it could be contained. The interest rate was close to its historic low of 2% a year.

In that scenario, the Ibovespa surpassed 130 thousand points, that is, an appreciation of almost 10%. As a result, many investors migrated their investments to the variable income market.

As is natural with trend changes, the fall was faster and larger than the rally. This frightened investors who started a risk reduction process.

Some investors who enthusiastically believed that it would make sense to have 100% of the resources in shares, are now questioning whether it should be zero.

For no investor a 100% allocation on the stock exchange is reasonable. The reason for this is that devaluations are natural to the market and having some position in fixed income gives you the opportunity to take advantage of the declines.

Also, no allocation would only make sense for an extremely risk-averse investor or investor with an investment horizon of less than 2 years.

In that range, what would be the most appropriate long-term strategic average percentage for you?

First, it’s important to understand the difference between strategic and tactical allocation. Strategic allocation is the long-term one that is related to the investor’s profile. Tactical participation, on the other hand, refers to a variation of the first and is related to the market scenario and short-term perspective.

Thus, for example, defining the strategic allocation of 15% in shares, it is possible to create a tactical allocation range from -10% to +10% of this percentage, that is, from 5% to 25% of risky investment.

Realize that the important proportion is related to the long term and your investor profile.

At this point, the question arises: if you are a moderate investor, should you have 10%, 20%, 30%, or 40% in shares? And could its profitability be negative?

Unfortunately, the questionnaires offered by brokers and banks are not suitable for you to discover your profile. And even after discovering the profile, it is not possible to relate the profile to the proportion of investment in shares.

To complicate matters, brokers give incomprehensible names for the level of aggressiveness of the profile, for example, visionary, strategist or sophisticated. What does that mean? Who is more aggressive?

I’ll simplify it for you.

We can simulate what outcome the portfolio would have in a bad year for each share allocation. So, to choose the allocation, it would be enough to answer the question: how much would you accept in return for your portfolio in a bad year?

For example, if in a bad year for the market, you accept that the return on your portfolio is 1.4%, you could have a 30% strategic allocation in stocks. The other 70% of the portfolio should be invested in lower risk fixed income assets, for example, CDBs or fixed income funds.

In this simulation, it was considered that fixed income assets would be invested at the current Selic rate of 9.25% per year. In the share portion, only the investment in Ibovespa was considered. The result could be better if you diversified internationally, or worse if you decided on a more aggressive portfolio than the Ibovespa.

To arrive at this calculation of the share exposure ratio and expected return in a bad market, the Value at Risk concept was used, known by the acronym in English VaR (Value at Risk). I already explained about this risk indicator in a previous article.

I reinforce that this does not mean the worst possible return, but the worst-case scenario with a 90% probability. Thus, there is a 10% probability of the result being even worse. Therefore, this would only be a metric that guides your profile and not the result of your portfolio.

I believe the table above will be helpful for you to make an assertive long-term decision about your stock investment.

Michael Viriato he is an investment advisor and founding partner of Investor’s House

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