A balanced investment portfolio is the basis of every good investment. But how do you build and manage good portfolios to make your finances grow?
What is an investment portfolio?
An investment portfolio is a collection of different types of assets. Portfolios can contain stocks, mutual funds, exchange-traded funds, cash, and other financial instruments. An investment portfolio is akin to a house where you keep all your financial assets under one roof.
Investment portfolios comprise primarily of stocks, which are shares of a company. Owning stock in a company makes you a part-owner of that company. Exactly how much of the company you own is dependent on the number of shares you buy.
Bonds are also in investment portfolios. A bond is a type of investment with a maturity date attached. On this date, you receive the principal amount you paid for the bond, plus interest.
“Fixed-income investments” is another term for bonds. So, you will always know the amount due to you on the bond’s maturity date.
Alternative investments are less prevalent in trade transactions than stocks and bonds. Nonetheless, they do often crop up in investment portfolios too. Alternative investments include gold, real estate investment trusts (REITs), and oil.
Asset classes are the internal organizing principle of investment portfolios. Investors categorize each class according to how the asset responds to market conditions. For this reason, it makes sense to put similar investments in the same asset class.
An asset allocation is part of investment portfolios too. It refers to the spread of funds across the different asset classes. Your appetite for risk – as well as your financial goals – influences your asset allocation. These are significant considerations when working on your asset allocation.
Types of portfolios
There are different types of investment portfolios, but the difference between types is the strategy used to make investment choices. There are three main types of portfolio investments;
Growth Portfolio: It is made up of investments in young companies and companies with above-average growth. These companies are likely to yield profitable returns at a high growth rate. As a result, growth portfolios are riskier than other kinds of portfolios. But their higher rewards tend to balance out their more significant risk. Emerging markets focus on growth portfolios
Income Portfolios: The main aim of an income portfolio is to earn a steady income from investments. As a result, stocks and bonds are commonly held in income portfolios. Investing in stocks usually occurs through mutual funds. Mutual funds carry less risk than putting your money into individual stocks. Bonds tend to yield lower returns than stocks. But they do offer a predictable return, which is what you want in an income portfolio.
Value Portfolio: Focuses is on low-cost assets. An investor making use of this strategy pays careful attention to the market. The state of the market plays a major role in the valuation of assets. Tough times, like the pandemic, affect businesses in negative ways as it makes it harder for them to keep their heads above water. During such times, the savvy investor will snap up assets at prices below market value. Prices can go back up once the economy recovers, and this leaves you with a portfolio of assets that have increased in value.
How to build a portfolio
When putting your portfolio together, think first about why you want to invest; bear your financial goals in mind. This thought process will help you get a firm grasp of what the purpose of your investment portfolio will be. Your time horizon is also relevant to your investment choices. Take into consideration, your investment timeline as you make your choices.
When building your portfolio, one thing to consider is whether you want to get external help. There are many technological advances in the world of finance, so a plethora of services lies at your fingertips. A robo-advisor is an excellent way to get extra help. Robo-advisors build your ideal investment portfolio based on your risk appetite.
Buying and selling stocks in quick succession can be thrilling. This sort of transaction is called investment turnover. Unfortunately, investment turnover can destabilize investment portfolios. So, if you want a sturdy portfolio, try to keep investment turnover as low as possible.
High investment turnover attracts transaction costs. It doesn’t make sense to spend your hard-won profits on avoidable expenses. Instead, exercise patience by letting your investments reach their full financial potential.
Be meticulous about how much you spend on an asset. A value portfolio, for example, is one where the price is the deciding factor for the kinds of investments included in the portfolio. The lower the price of an asset, the better the profits margin.
When building your portfolio, the adage rings true – don’t put all your eggs in one basket. Do not rely on one type of investment. Instead, diversify to reduce market risk. Returns on investments can be uneven, so it is best to have a variety of assets to counter this trend. That way, you can also manage the risks involved in investing.
Investment portfolios and risk tolerance
Part of building a portfolio involves thinking carefully about your risk appetite. So much of your personality is bound up in your approach to risk. It is advantageous to take the time out to carefully consider how you will deal with the inevitable rises and falls of an ever-changing market.
You probably know yourself better than anyone else. So, it would help if you had a fair idea of your attitude towards the fluctuations in the market. Are you someone who is a sore loser, unable to handle investment losses? Then you might be better off with a moderate portfolio that can get you returns on investment in the short term. This kind of portfolio is also suitable for those with sensitive stomachs that cannot handle the volatility of the markets.
On the other hand, aggressive portfolios are suitable for people who have a high tolerance for risk. These folks can wait a while for their investments to yield returns. Remember that your asset allocation is how your money is spread across the different assets in your investment portfolio. Therefore, your risk tolerance should directly affect your asset allocation.
High tolerance for risk may show up in a narrow asset allocation, with less variety in your asset classes. Conversely, low tolerance for risk may show up in a more diversified asset allocation. Your risk tolerance is also directly related to the timeline of your financial goals. If you invest for short-term gains, you might want to exercise more caution. If the market dips as it did back in 2008, your chances of financial recovery would be slim to none. It would be best to lower your appetite for risky investments in this scenario.
If you have long-term goals, you have many decades to achieve your financial objectives, so your risk tolerance might be a lot higher. Therefore, market volatility will not affect your investments as much. If the market experiences a short, sharp downturn, there would be enough time for your investments to recover.
The importance of rebalancing
So, now that you know the different types of investment portfolios, you know how to build one and you understand your risk tolerance levels, it is time to add a few portfolio maintenance skills to your financial armoury.
Portfolio management is the art of rebalancing your investment portfolio and getting it to work for you. A balanced portfolio yields financial rewards and gives peace of mind. Time affects everything, including your investment portfolio. However, the effect of time is usually to destabilize your carefully curated asset classes and asset allocation.
Markets rise and fall all the time. This volatility will inevitably affect your stocks and bonds, for example. One depreciating stock could throw a spanner in the works. Financial experts suggest that you rebalance your portfolio at specific intervals. For example, it could be every three months, six months, or 12 months.
You can also rebalance when any one of your asset classes changes unexpectedly. For example, one of your asset classes grows by 5%. You could rebalance by selling some of the funds in this class.