Which type of portfolio might a young investor who is not afraid of risk choose?

A young investor with a high level of risk tolerance will find his calling in an aggressive investment strategy. This strategy is based on the premise that the investor is quite comfortable with taking high risks in order to increase the potential of high returns. This also means that such an investor should be willing to absorb a capital loss, if it occurs, on his way to superior portfolio performance. The hope of high capital appreciation far exceeds the worry about conserving the principal for such an investor.

The reason why some young investors may prefer this strategy even at the cost of some intra-period loss of capital is that their long investment horizon allows them the opportunity to ride out tough market situations which may erode their capital.

We can look at an aggressive investment strategy in two ways: via direct investment in financial markets or via fund vehicles like mutual funds and exchange-traded funds (ETFs).

The direct route:Though there is no set rule which differentiates an aggressive investment strategy from others, but over three-fourths of a portfolio’s investment in risky asset classes can be termed as aggressive. For this route, an investor needs to open an account with a broker post which he can invest in risky investment classes like equities, commodities, and high yield bonds. Among equities, products like futures and options are at top of the riskiness meter.

To elucidate the above, an allocation of 65% of the portfolio to stocks, 10% to commodities and the remaining to fixed income and cash can be termed as aggressive. The same can be said for 80% exposure to equities and 20% to bonds.

But an aggressive strategy is not just defined by exposure to the aforementioned asset classes and products. It is also determined by what kind of securities are held in those asset classes. For instance, in the 80-20 portfolio outlined above, if the 80% portion that is invested in stocks only comprises of large cap or blue-chip stocks then it will not be considered as aggressive as a portfolio which comprises of mid and small-cap stocks. Similarly, the only type of bonds which can be termed as aggressive are high yield bonds whose behaviour has been seen to mimic equities more than other bonds.

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The fund route: For those young investors keen on using mutual funds to create an aggressively positioned portfolio, funds which invest in mid and small-cap stocks or follow a concentrated portfolio strategy are to be targeted. Funds which invest in riskier markets abroad like those classified as emerging and frontier markets are also worth considering.

Though ETFs are passive investments which simply aim to mirror their underlying benchmark, there are some which are much more aggressive than others. One such category comprises of those funds which mimic a smart-beta index which has been designed to outperform the market. Others include leveraged ETFs (which rise or fall 2 or three times the market movement) and inverse ETFs (which rise if markets fall and vice-versa).

A common thread between the two routes towards forming an aggressive strategy is active management. While moderate and conservative investors can be content pursuing a buy-and-hold strategy, aggressive investors need to undertake more portfolio changes in order to make the most of what markets have to offer at any given point of time. Higher portfolio turnover does mean higher costs, but the intent is to far outperform broad market indices so that the higher cost gets taken care of by favorable market movement.

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