An investment portfolio is one of the first words you hear when you want to begin investing. It can be intimidating because many people do not know what an investment portfolio is and why it is important when you begin investing. Inevitably, they hand their money over to a “professional” to create one for them.
Here we will educate you on what an investment portfolio is, touch upon 2 types of investment portfolio strategies, and how to create a portfolio using investments that are suitable for beginners.
What is an investment portfolio?
In a nutshell, an investment portfolio is “a collection of financial securities designed to provide a profit or cash flow ” – Dr. Sadi Ozelge.
When you buy stocks, bonds, or mutual funds, they are collected together and now make up your investment portfolio.
Think of an investment portfolio like a pie and each investment you purchase is a piece of that pie. Or you can think of an investment portfolio like an artist’s portfolio. Instead of including all of the artist’s drawing examples, an investment portfolio includes the mix of securities you bought.
How to build an investment portfolio
When you are first starting to invest, the volume of available information can seem daunting. In the past, Americans didn’t have to think about preparing and planning for their financial futures. That preparation and planning were handled by their employer in the form of pensions.
These days, very few jobs provide pensions. The majority of individuals now have to fend for themselves when it comes to planning for their retirement and financial future.
If you want to plan for your retirement now, your options are a 401k, an IRA or the equivalent for the nonprofit and government sectors.
The only information you are given is how much your employer will match. If you use one of these options, no direction is given as to where to place your money.
What to consider
When building your investment portfolio you need to keep the following factors in mind:
- The type of investor you are
- Risk Tolerance
- Asset Allocation (Investment Mixture)
- The strategy that works for you
What type of investor are you?
When it comes to building a portfolio there are different strokes for different folks. You have to decide early on how much involvement you want to have.
Some people want minimal involvement with their portfolios. They would rather pay someone to handle their investments for them.
Some people like to be a little more involved in the process and set up the portfolio themselves, but then only look at it once in a while (annually) to make adjustments.
Then you also have those who love monitoring their investments and make adjustments regularly.
We suggest that taking care of your portfolio on your own is completely feasible.
By educating yourself on what to buy, based on your goals and risk tolerance, you can achieve positive returns and save on fees.
If you choose later on to have someone else manage your investments, it won’t be done because of lack of knowledge.
Think about learning how to drive. It seems intimidating when you first start, but then most people get the hang of it. Later on, after you know how to drive, then maybe you will be willing to hand the wheel over to a chauffeur.
It doesn’t mean the chauffeur can drive better. It just means you made a choice based on other factors that didn’t include a lack of knowledge.
Risk Tolerance – what is it and why is it important?
Risk tolerance is understanding how you can stomach the risk of losing your money vs the potential rewards.
The timeline of when you need your money and the goals you have for your investment portfolio will determine your risk tolerance.
There are many surveys that you can take online that will help you determine your risk tolerance. If you are comfortable taking on riskier investments because you value the possibility of a higher reward, then you have high risk tolerance.
If you are like us, your risk tolerance is much lower. We value safety in our portfolios. However, we do our best to balance our risk tolerance with reward so that our portfolios grow at a rate we are comfortable with.
We have kids keeping us up at night, no need to add stress from our investments to the list of things that will keep us awake.
However, seeking too much safety will impact your gains so you need to find the right balance that works for you.
If you want to read further on about risk tolerance, check out this link to investor.gov.
You heard the saying – don’t put all of your eggs in the same basket right? Well, the same applies when it comes to investing.
The purpose of investing is to make money or at least not lose the money you put in.
If you don’t spread your money across different investment types, you are increasing the probability of losing. You’re essentially putting all your money on red like in a game of roulette.
You want to have a diverse portfolio so that there is more of a balance. If one asset you purchased is performing below your expectations another one could support the disruption.
Asset allocation, in this case, means taking the money you have and allocating it percentage-wise across different asset classes.
There are numerous asset classes, but for beginners, it is best to focus on the higher level asset categories and then choose a few asset classes from there.
For simplicity, we will focus on ETFs and Index Funds which are ideal for the average new investor and provide diversification at the same time.
The percentage of each asset class in your depends on your preference. Many online brokers have online questionnaires that will help you determine a breakdown that is ideal for you and your specific goals. Charles Schwab provides a relatively simple one to get started.
Examples of Asset Classes for a Portfolio
- Equities – Stocks
- ETF ex: SPY
- Index Fund ex: SWPPX
- Fixed Income – Bonds
- ETF ex: IGEB
- Index Fund ex: FTBFX
- Money Market – Marcus or Capital One 360 Account
- Alternatives Investments Commodities (ex gold or real estate)
- ETF ex: IAU
- Index Fund ex: VNQ
Investment Portfolio Strategies
When setting up your portfolio, you need to understand what your goals are for the money that is in or will be in your portfolio. Understanding your goals will help you determine what strategy you will follow for your portfolio.
Most portfolio strategies fall into two categories, growth or income.
Portfolios set up for growth, tend to be riskier. The strategy is based on picking assets that have a high potential for growth, are fast-growing, but have some uncertainty in their future because they haven’t been established for long. This presents a risk for the investor but also higher rewards.
These companies can be game-changers and concentrate on putting their money back into the company and not paying money out to their shareholders.
Income investing is a strategy that focuses more on companies that have steady and reliable growth.
These companies are more established and pay their shareholders a set income in the form of a dividend.
Stability replaces risks and rewards with this kind of asset. The goal of portfolios that follow this strategy is more safety and predictability.
Investing is like any new skill you acquire. It may seem difficult in the beginning but once you familiarize yourself with the basics, you can hit the ground running. The key is to know yourself (how much risk can you tolerate), your goals, and how hands-on you want to be. When you begin to educate yourself, you will see that it is not as intimidating as you initially perceived.
If you want a crash course on how to begin to invest, be sure to check out our investing guide
Are there any skills you now possess that you thought were difficult to learn before starting? The first thing that comes to mind for us is riding a bike. We hope you enjoyed the article and please share.
Nadia is a Financial Independence Coach from New York City. She holds a B.A from Columbia University and worked 13+ years in Investment Banking and Financial Services. She is an entrepreneur, investor, and partner at Wealth Twins LLC. She reached Financial Independence in her 30’s and is passionate about showing others how to achieve the same.