An investment portfolio is a collection of assets that puts your money to work for you. Capital invested in carefully selected funds or stocks can deliver meaningful returns instead of falling behind inflation in a low-yield bank savings account.
Investors can buy mutual funds and exchange-traded funds, or ETFs, that hold various stocks, bonds and other securities. This path is easier than picking individual stocks because a fund manager handles the investments and the research behind them. Investors can also construct their own portfolios by identifying stocks, bonds and other assets that align with their objectives.
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A financial portfolio doesn’t have to include just funds, stocks and bonds. You can also buy alternative assets such as real estate, real estate investment trusts, commodities, precious metals and other investments. It’s possible to directly own these assets or, again, invest in a fund that manages the alternative investments for you.
How to Build an Investment Portfolio
A critical component of any investment portfolio is diversification. You don’t want to put all of your eggs in one basket. If the one stock you put all of your savings into collapses, you will be starting over.
Spread Out Your Investments
Taylor Kovar, a certified financial planner and founder and CEO of 11 Financial, shares the benefits of portfolio diversification: “Diversification is essential for managing risk and optimizing portfolio returns. By spreading investments across different asset classes, industries, geographic regions and investment styles, individuals can reduce the impact of market fluctuations on their overall portfolio performance.”
Many investors tout the advantages of portfolio diversification, but which securities should go in your portfolio? Bonds make sense for some investors, but growth stocks appeal to others.
There isn’t one solution that applies to everyone. So, first things first: Consider your risk tolerance and time horizon.
Know Your Risk Tolerance
Understanding your risk tolerance will help you choose investments that match your comfort level with potential ups and downs. That will also determine how much of your portfolio is allocated to each type of investment.
High-yield bonds, cryptocurrencies, initial public offerings and penny stocks fall into the high-risk category, for example, while Treasury bonds and ETFs, certificates of deposit, and dividend aristocrat stocks might be on the lower end of the risk spectrum for many investors.
Consider Your Time Horizon
Depending on whether you’re ready to retire or just starting your investment journey as a young professional, you can choose a different mix of short-term and long-term investments.
Many investors, especially those who are far from retirement, tend to focus on growth-oriented stocks because they can recover from downturns more easily. These young investors still have many years left in their careers, so they often have a higher risk tolerance. As investors get older, they tend to shift their assets toward lower-risk dividend stocks and bonds.
You will have to create a brokerage account with a firm like Fidelity or Vanguard to buy stocks, bonds and funds. The requirements and paths of entry vary for alternative assets like real estate and gold. Aspiring investors should compare these and other brokerage firms before deciding which one is right for them. It is possible to create accounts with multiple firms.
Advantages of an Investment Portfolio
If you keep your money in the bank, it won’t budge much. You might have a high-yield savings account, but its real returns will usually be much lower than what you could earn with an investment portfolio.
The main advantage of creating an investment portfolio is the potential for financial growth and wealth building over time. By carefully selecting a mix of assets, you’ll see your investments grow, helping you work toward financial goals like retirement or buying a home.
Magic of Compounding
While the gains probably won’t be much within a few days or weeks, the real growth takes place when investors give their portfolios several years to compound. If you invest $10,000 and generate an annualized 8% return for 40 years, for example, your portfolio will grow to $217,245. That doesn’t even include additional contributions.
Individuals who build large investment portfolios can eventually generate enough cash flow to cover their living expenses. These portfolios can facilitate a quicker and smoother retirement. More stable cash flow gives you more dependable choices, and an investment portfolio can help you achieve financial goals.
“An investment portfolio provides the opportunity to grow wealth over time through capital appreciation, dividends and interest payments,” Kovar says.
Lower Risk
Investment portfolios also improve diversification, which minimizes your risk. You won’t have to stress about the performance of a single stock and worry about it making or breaking your finances. You can also choose a goal and periodically readjust your portfolio as you see fit.
Risks in an Investment Portfolio
Investment portfolios are a common vehicle for a quicker retirement and long-term wealth. However, constructing these portfolios can lead to several disadvantages if you aren’t careful:
Economic Downturns
The most obvious risk is the potential to lose money. Investing is fun when everything is going up, but sharp corrections and economic downturns will test the mettle of the most experienced investors.
Markets can be volatile, and there’s always the chance that investments may not perform as expected, which could lead to losses. Some investors can fall into the trap of buying high and selling low as emotions get in the way or as stocks in the portfolio lose their catalysts for growth.
Expenses
While market risk is on top of every investor’s mind, there is a more subtle risk that can hurt your long-term gains: fees.
“Individuals should be mindful of investment costs and fees, including management fees, transaction costs and expense ratios associated with investment products,” Kovar says. “Minimizing costs can enhance net returns over time and improve the efficiency of the portfolio.”
An investment portfolio with considerable options trading can also get expensive. Most brokerage firms charge a 65-cent fee for a single options contract trade. It’s possible to rack up thousands of dollars in fees each year if you regularly trade options. That doesn’t even include potential losses.
Restricted Liquidity
Some asset classes are also less liquid, meaning it can take longer to turn them into cash. While you can turn stocks, bonds and crypto into cash within minutes, it can take months to convert real estate, precious metals and similar assets into cash. Some assets take even longer.
Balancing Risk vs. Reward
The risk of losing money shouldn’t deter most people from starting an investment portfolio. Picking the right investments can lead to long-term wealth, and your money will lose purchasing power if you keep it in the bank. A financial advisor can help you determine the right investment portfolio allocations.
Investors also need to take a disciplined approach to their portfolios, know their goalposts and establish objectives based on their risk tolerance. Picking reliable companies and holding on to those stocks for many years can be a winning formula, but so can a mix of investment strategies.
As the saying goes, time in the market beats timing the market. But burying your head in the sand as market conditions change is not always a wise move, either. A moderate approach that balances risks and rewards can result in a successful investment portfolio.
Sample Investment Portfolios
The ideal portfolio for each investor depends on lifestyle, family obligations, goals, age, retirement status, risk tolerance, investment type, taxes, time schedule and so much more, so it’s not a one-size-fits-all prospect.
That said, here’s an abbreviated example of a middle-of-the-road ETF portfolio for retirement suggested by Morningstar. The portfolio takes long and short time horizons into consideration and focuses on keeping expense ratios low:
ETF Portfolio for Retirees
Time horizon in retirement: 15-25 years Risk tolerance and capacity: Moderate
— 10% cash (certificates of deposit, money market funds, etc.)
— 40% diversified bond ETFs, including Vanguard Short-Term Bond ETF (ticker: BSV)
— 20% Vanguard Dividend Appreciation ETF (VIG)
— 15% Vanguard Total Stock Market ETF (VTI)
— 15% Vanguard FTSE All-World ex-U.S. ETF (VEU)
Simple Investment Portfolio
For those who are earlier in their investment journey and don’t want to go all-out on picking a wide variety of funds, an investment portfolio can be much simpler. It could be one target-date fund, if you really want to keep it bare bones, though even that approach is not without risk.
An example of a Morningstar-recommended minimalist fund portfolio includes Vanguard Total Stock Market (VTI), Vanguard Total International Stock Index (VTIAX) and Vanguard Total Bond Market Index (VBTLX), with percentages adjusted for risk tolerance, time until retirement and more.
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What Is an Investment Portfolio? Definition, Nuances and Examples originally appeared on usnews.com
