An investment portfolio is essentially a carefully curated collection of assets that aims to achieve specific financial goals while managing risk effectively. Having a well-constructed investment portfolio is crucial if you are seeking to build and protect your financial future.
Are you curious about what it takes to build a solid investment portfolio?
Keep reading because, in this post, you will understand better what an investment portfolio is and the various steps you have to take to build an investment portfolio.
What is an Investment Portfolio?
An investment portfolio is a collection of financial assets like stocks, bonds, and ETFs (Exchange-traded funds) curated with the expectations that they would yield returns, grow in value, or do both.
Why is an Investment Portfolio Important?
Building an investment portfolio is an essential part of a sound financial plan that can help you achieve financial stability and security. Here are two benefits of creating one.
1. Diversification
Creating an investment portfolio is crucial because it enables you to diversify your investment and effectively manage risk. By investing in a variety of assets such as stocks, bonds, mutual funds, and real estate, investors can reduce the impact of market volatility on their overall returns.
2. A Source of Income
A well-diversified investment portfolio can also provide a steady income stream through interest, dividends, and capital gains. This can help you achieve your long-term financial goals, such as retirement or funding projects.
How Can I Build an Investment Portfolio?
A great start to succeeding as an investor is to have an investment portfolio. You need to know how to create one that fits into your goals and timeline. Here are 4 steps to take in building an investment portfolio.
Step 1: Decide Your Asset Allocation
Asset allocation is an investment strategy that involves thinking about why you want to invest (your goals and objectives), your risk tolerance, and how long you plan to hold an investment (investment horizon).
In other words, in creating your investment portfolio, you need to think about:
Your goals: why are you investing? For retirement? For a project?
Your level of tolerance: Are you willing to take a chance on possibly losing some money in exchange for a chance at bigger rewards? Are you a Conservative Investor who prefers to invest in assets with low risks even if the return is low? Or are you an Aggressive Investor who is willing to invest in high-risk assets to potentially get a higher return on investment?
The duration you plan to keep an investment: If you’re saving for retirement, you’ll likely leave your investment for the long term. Whereas, if you’re a young person looking to make ends meet, you’d likely invest for short-term periods.
When creating your asset allocation, it’s better to diversify between high-risk investments—that can potentially bring high returns and moderate-risk investments—that would likely yield moderate returns. That way, you’re getting the best of both worlds.
Step 2: Choose your Asset
After you’ve decided on your goals, risk tolerance, and duration of investment, you proceed to allocate your assets in percentages across different financial assets using your risk assessment. Let’s work with stocks, bonds, ETFs, and mutual funds.
- Stock Picking
When you buy stocks, you own a small part of a company. People buy stocks because they think the price of the stock will go up. However, there is also a risk that the stock price will not increase or might even go down. To select stocks for your portfolio, pick the ones within your risk tolerance (low-risk, moderate risk, or high/aggressive risk tolerant).
You should also consider factors like the sector, market capital, and type of stock. You should also dedicate time to monitoring the changes in the stock price and company news so you can adjust stock volume as needed. You can learn more about buying stocks.
2. Bond Picking
Bonds are long-term, interest-bearing loans to businesses or governments. They are safer investments with low risks but their returns are lower than stocks. Bonds are known as fixed-income investments because you know how much interest you get in return as you invest.
This fixed rate of return for bonds can balance out other riskier investments, like stocks in your investment portfolio. When selecting bonds, factors such as a coupon, maturity, bond type, credit rating, and the general interest-rate environment should be taken into account.
3. Mutual Funds
Mutual funds offer a variety of asset classes and are managed by professional fund managers who pick stocks and bonds for the portfolio. However, the management fee charged by the fund managers will affect your returns. Index funds are passively managed and have lower fees since they mirror an established index.
4. ETFs
If you’re looking for an alternative to mutual funds, ETFs are a great option. They’re like mutual funds but they trade like stocks. They are grouped by sector, capitalization, and country and passively track a chosen index or another basket of stocks, offering diversification and cost savings over mutual funds. ETFs can be used to complement your investment portfolio by covering a broad range of asset classes.
Read Also: How Long Should I Leave my Investment?
Step 3: Distribute your Assets
If you’re a Conservative Investor with a low-risk tolerance, for example, you could allocate 50% of your portfolio to bonds, 30% to cash and 20% to stocks. An Aggressive Investor, with a higher risk tolerance, on the other hand, may allocate 70% of the portfolio to different stocks, 20% to bonds and 10% to cash. While a moderate risk-tolerate investor may allocate 60% of their portfolio to stocks and 40% to bonds.
For short-term goals, a conservative investor may allocate 40% to stocks, 50% to bonds, and 10% to cash. For medium-term goals, a moderate investor may allocate 60% to stocks, 30% to bonds, and 10% to cash. For long-term goals, an aggressive investor may allocate 80% to stocks, 15% to bonds, and 5% to cash.
To preserve your capital, as you get older, you can adjust your allocation to more percentages in bonds and less in stocks. This is because, as you get older, your risk tolerance may reduce and you may not have the time and energy to replenish your capital. You’d likely want to preserve your capital as you get closer to retirement age.
Step 4: Assess & Monitor & Manage Your Investment Portfolio
After you have curated your Investment Portfolio, you’ll need to monitor and assess them from time to time as the market price changes. If one type of investment has grown a lot, it might be taking up too much space in your portfolio, and you might need to sell some of it and buy more of something else.
Also, your financial situation, how much risk you’re willing to take, and what you need the money for might change over time. If they do, you might need to change what you’ve invested in. If you want to take less risk, you might sell some of your riskier investments. If you want to take more risks, you might buy some more risky investments.
Rebalancing your investment portfolio means making sure your portfolio is still balanced the way you want it to be. You check how much you have invested in each type of investment and compare it to what you want. If you have too much of one kind, you sell some and buy more of another kind, so you have the right amount of each.
Types of Investment Portfolio
As I mentioned earlier, having an investment portfolio helps you diversify your investment, and manage risks based on your financial goals. Because there are many ways to diversify and factors to consider, there are different types of investment portfolios. According to Investopedia, there are 5 types of Investment portfolios.
1. Aggressive Investment Portfolio
An aggressive portfolio tries to make big gains but also comes with big risks.
To make big gains, people who have an aggressive portfolio usually invest in stocks that are very sensitive to the overall market. These stocks also fluctuate in price more than others. People who are aggressive investors like to find companies that are just starting to grow and have something special that makes them different.
2. Defensive Investment Portfolio
They do well both in bad and good times. This is because the stocks are in the category of essential goods people need every day to survive. Goods like food, beverages, household goods and hygiene products. Examples of stocks within this category are Walmart Inc (WMT), Procter & Gamble Co (PG), Nestle SA (NSRGY), Coca-Cola Co (KO), PepsiCo Inc (PEP).
3. Income Investment Portfolio
The income portfolio prioritizes investments that generate income through dividends or other distributions to stakeholders. While some of the stocks in this portfolio may also belong to a defensive portfolio, they are primarily selected for their high yields.
Examples of this type of investment are Real estate investment trusts (REITs) and master limited partnerships (MLP). These companies return much of their profits to shareholders in exchange for favorable tax status. REITs, in particular, are a way to invest in real estate without the hassles of owning real property.
4. Speculative Investment Portfolio
Investors under this category take more risks than others and it can be likened to gambling. This type of portfolio may include initial public offerings (IPOs), potential takeover targets, or companies developing a single breakthrough product or service, like those in the technology or healthcare industries. A young oil company on the verge of releasing its first production results could also be considered a speculative play.
5. Hybrid Investment Portfolio
Building a Hybrid Portfolio involves exploring other investment options like bonds, commodities, real estate, and even art. There is a lot of flexibility in creating a Hybrid Portfolio, as it combines multiple asset classes to offer diversification. This approach offers diversification across multiple asset classes.
I hope this article helps you make informed decisions while building your investment portfolio.
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