Sep 20, 2023
What Is an Investment Portfolio?
|What is an investment portfolio?|
An investment portfolio is a collection of all the investment assets you own, such as stocks, bonds, and funds. The goal of an investment portfolio is to generate returns while also managing risk. Every investor’s portfolio is unique: a thoughtfully curated portfolio of investments can be customized to your personal risk tolerance, financial ambitions, and time horizon.
In this article, we’ll cover:
- Types of assets for a portfolio
- Importance of diversification
- How to build a portfolio
- Common mistakes to avoid
Types of investment assets for your portfolio
Common types of investments in a portfolio include stocks, bonds, exchange-traded funds (ETFs), and mutual funds. Some people also hold things like real estate, crypto, and commodities such as precious metals.
Each type of investment in your portfolio is like a building block, supporting your overall investing strategy. Each asset brings its unique characteristics to the table, such as level of risk, potential returns, and the way in which it can generate returns.
Importance of diversification
The saying “Don’t put all your eggs in one basket” certainly holds true in the world of investing. That’s where diversification comes into play. It involves spreading your investments across various asset classes like stocks, bonds, funds, and more. This strategy helps reduce the impact of a single underperforming investment on your entire portfolio; if one asset falls in value, that loss can be balanced by gains in other investments.
For example, say you’ve created a portfolio in which 60% of your money is invested in stocks and 40% is invested in bonds. Stocks tend to be more volatile than bonds; if the value of some of your stocks decreases one month, the value of your bonds is likely to hold steady, reducing the impact of falling stock prices on your portfolio as a whole.
In addition to spreading your investments across assets, you can further mitigate risk by diversifying within asset classes. For instance, you may want to hold stocks in multiple different sectors and buy various types of bonds. Investing in ETFs, which are baskets of multiple investments, can also help add more diversification to your portfolio.
How to build a portfolio
Building a well-structured investment portfolio is a bit like creating the perfect playlist: it’s all about customizing to your particular preferences. Your financial goals and risk tolerance will help you determine the right mix of investments for you.
Set your investment goals and risk tolerance
Begin by defining your financial goals. Are you working toward long-term needs like retirement or your kids’ education? Are you more focused on medium-term goals like buying a house within three to five years? Identifying what you want to achieve and how far in the future those aims are can guide you to investments that are most likely to generate a return within your time horizon.
Next, assess your risk tolerance, which is how comfortable you are with uncertainty about your portfolio’s future returns. Every investment carries risk, including the risk that you could lose money. Your age, income, and goals can help you decide if you’re most comfortable with a conservative, moderate, or aggressive approach to risk; this will help determine how you’ll allocate your money across different asset classes.
Depending on when you intend to distribute your investment earnings, you might choose riskier investments that pose a greater potential gain, or keep your asset mix more conservative so you can be confident in your nest egg. For example, younger investors saving for retirement might take a more aggressive approach, investing in more volatile assets that could maximize long-term returns even if they lose value in the short term. If you’re close to retirement, however, you may want a more conservative portfolio in which you favor stability over high returns.
Determine asset allocation
Asset allocation is like deciding how much airtime each genre gets on your playlist. It involves allocating a percentage of your portfolio to different asset classes. Many investors use a rule of thumb based on age: subtract your age from 100 to determine the proportion of stocks to include. For example, if you’re 30, this rule suggests allocating 70% to stocks and 30% to less volatile assets, like bonds.
However, personalization is key, and age isn’t the only determining factor in asset allocation. There’s no one-size-fits-all definition of a “good” investment portfolio: your asset allocation should align with your specific goals, risk tolerance, and time horizon. You might decide that stability is more important than higher gains, opting for an asset allocation of 40% stocks and 60% bonds, regardless of your age.
Choose investments within each asset class
Now that you’ve determined your asset allocation, it’s time to pick specific investments within each category. Just as you’d pick the best songs for your playlist, choose individual investments within each asset class wisely. This step fine-tunes your portfolio’s composition.
- Stocks: When you buy stock in a company, you become a shareholder, and your potential profits depend on the company’s performance. When deciding which companies to invest in, research financial fundamentals like revenue, net income, earning per share, and price-earnings ratio. You might also want to look bigger-picture at the different stock sectors and industries to ensure you’re diversifying within this asset class.
- Bonds: You have several options for investing in bonds: U.S. government bonds, corporate bonds, and municipal bonds. And there are different types of bonds within each of those categories. Research the specifics of each, including issuer credit ratings and the market risk of interest rates.
- ETFs: Putting your money into funds provides some built-in portfolio diversification because each fund is a basket of multiple securities. There are a vast number of ETFs available, so research the different options and the costs and expense ratios of each one you’re considering.
- Real estate: There are many ways to invest in the real estate market, from buying shares in real estate investment trusts (REITs) to actually purchasing and renting or flipping properties. When exploring your options, you’ll want to analyze market conditions and trends to understand the potential risks and rewards.
Keep these key factors in mind
Every asset in your portfolio has unique characteristics. As you make your selections, these additional considerations can help inform what to invest in based on your needs:
- Liquidity: How quickly can you convert your investment into cash? Stocks and shares of ETFs can generally be sold for cash pretty quickly, while bonds often come with a set term. Consider whether you need ready access to the money you’ve invested as you choose the assets for your portfolio.
- Time horizon: How long will it take for an investment to turn a profit? Some assets tend to have slow-and-steady growth, while others may fluctuate quite a bit. And certain investments, like retirement accounts, can’t be accessed until you reach a certain age. Think about when you plan to cash in your investments.
- Tax implications: When you sell an asset, you’ll generally have to pay taxes on your earnings. But different investment vehicles come with different tax considerations. For instance, retirement accounts like IRAs usually come with tax advantages. And the amount of capital gains tax you pay on earnings from stocks is determined by things like how long you hold an asset and your tax status.
Monitoring and rebalancing your portfolio
Creating your investment portfolio isn’t a one-time task. Your financial goals, risk tolerance, and market conditions will inevitably change over time, so you’ll likely need to review and adjust your asset allocation regularly. For example, you may wish to shift the balance of stocks versus bonds as you get closer to retirement or develop new financial goals.
Additionally, market conditions are always fluctuating, and it’s important to keep an eye on how economic changes have affected your investments’ performance. Regular monitoring and rebalancing allows investors to ensure their portfolio stays aligned with their objectives and identify any potential issues.
Common investment mistakes to avoid
As you build your portfolio, keep an eye out for pitfalls that could undermine your goals.
- Overconcentration in a single asset: It can be tempting to put a large percentage of your money into an asset that seems exciting, like a rapidly growing stock. But that opens you up to the risk of volatility. Diversification helps cushion against potential losses and capture gains from different sources.
- Neglecting changes in financial goals: Life changes, and so might your financial aspirations. Regularly reassess your goals to ensure your investment strategy remains aligned with your ever-shifting circumstances.
- Ignoring portfolio review and adjustments: Experts recommend reviewing and rebalancing your portfolio once a year. Skipping this annual exercise could leave you with a portfolio that, over time, no longer supports your financial goals and investing strategy.
- Chasing short-term market trends: Trying to “beat the market” by frequently trading stocks based on market trends is generally riskier and more expensive than a passive investment strategy that’s focused on long-term portfolio performance.
Invest with intention
Building and managing an investment portfolio is a dynamic journey that should align and evolve with your lifestyle and financial aspirations. By understanding your goals and risk tolerance, you can prepare yourself to start investing with a diversified portfolio tailored to your needs. And the good news is, you don’t need a lot of money to start an investment portfolio. With Stash, you can begin your investing journey with any amount.
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