What is Portfolio
A portfolio is a collection of investments like stocks, commodities, bonds, cash, and cash equivalents, including ETFs (exchange-traded funds) and closed-end funds. People are of the opinion that a portfolio only comprises stocks, bonds, and cash, but this is not always the case as it need not be a rule. An investors’ portfolio may contain a wide range of assets including private equity investments, real estate, and art, etc.
Individuals can opt to manage their portfolio in an individual capacity, or they may allow a financial advisor, money manager, or another professional to hold and manage the same for them.
Equity stocks are the most generic component of a portfolio. These securities might prove to be a source of income because as the companies generate revenue and profits, it shares a part of it through dividends to its subscribers. In addition, these holdings can be sold at a higher price depending on the operations and performance of the company. Stocks have the potential to offer good capital growth over the long term through a rise in their market value over time with the increase in business & profits.
When individuals invest in bonds, they are lending money to the bond issuer, such as a company, the government, or an agency. A bond comes with a fixed tenure and maturity, which indicates that the principal used to purchase the bond is to be returned along with the interest accrued. Compared to equity, bonds offer lower potential rewards as they possess comparatively low risks.
Alternative investment options:
The other alternative investments could include assets or investments other than traditional securities like equity, bonds & debt securities. Some of the examples of these investments can be hedge funds, private equity, art, rare diamonds, antiques, etc.
These alternatives are commonly less widely traded than conventional investments such as shares and bonds.
Investors may consider their portfolio as a pizza that is to be divided into pieces of varying sizes, each part representing a different type of investment or asset class. One must aim to achieve risk-return portfolio allocation that is ideal for their goals and risk appetite. Nevertheless, shares, bonds, and cash are perceived as predominant building blocks for a portfolio, an investor may grow a portfolio with various types of other alternatives which may include gold stocks, paintings, arts, real estate among others.
Objective of Portfolio
One of the most significant aspects of portfolio management is concerned with the wisdom of diversification, which simply means not to put all your money in one pocket. Diversification attempts to reduce the risk by allocating the funds among various investment options, industries, sectors, market capitalizations, and other categories. Its objective is to maximize the returns for an investor by investing in different asset classes & subcategories that would react differently to market events because of their varied correlations. There are a number of ways to diversify the portfolio which are governed by factors like investor’s financial goals, risk appetite, return expectations among others.
How to Build a Portfolio (Step by Step)
Determine the goal:
Investors should ask themselves that what is their portfolio for and come down to a goal so that they can move on the right path towards an ideal direction.
Minimize investment turnover:
Some investors like to trade securities within a very short tenure. They need to know that this increases the transaction costs. Also, valuable investments do take time to pay off finally.
Not spending too much on an asset:
The higher the cost for acquiring an asset, the higher the break-even point would be to meet. So, the lower the price of the asset, the higher the probable profits.
Not rely on a single investment:
As it is often said, “Don’t put all your money in one pocket. The key to building a profitable portfolio is to diversify. When some investments are in a bearish phase, others may be bullish. Holding a wide range of alternatives helps to lower the overall risks for an individual.
Types of Portfolio
The investment can be either strategic- where an investor buys financial assets with the intention of holding onto those assets for a long tenure; or tactical - where an investor can actively trade the asset in the hope to achieve profits over the short term.
The portfolio for investors will vary depending on their risk appetite, requirements & other things. Some of the common model portfolios has been discussed below:
Aggressive, Equity-Focused Portfolio:
The asset comprising this investment generally would assume great risks as it offers great returns. Investors possessing a high-risk appetite seek out investments in equity securities of the companies. They would also have an allocation to companies in the introductory stage i.e. small caps, which offer a unique value proposition and have high growth potential.
This approach diversifies across asset classes. This requires taking a position in bonds as well as stocks, real estate, commodities, and even art. Often, a hybrid portfolio relatively fixes the proportion of bonds, stocks, and alternative investments. This is beneficial because historically, bonds, shares, and alternative options have exhibited less than perfect correlation amongst each other.
In this type of portfolio, investors allocate a lower portion of their portfolio in equity & other high-risk investments. The major allocation of the portfolio is made in debt securities & other fixed income generating instruments.
This type of portfolio gains from dividend-paying shares, fixed income-generating instruments, or other types of income yielding investments. These portfolios aim to generate regular & positive cash flow for the investors. REITs i.e. Real Estate Investment Trusts are also an example of income-producing investments.
Defensive Equity Portfolio:
A defensive portfolio would tend to aim at investments in stocks of consumer staples that are not influenced by downturns. Defensive stocks do well in the bearish as well as bullish phase. No matter how bad the economy is, companies that are into manufacturing essentials tend to survive.
How Risk Tolerance Affect Portfolio ?
Although a financial professional or advisor can create a generic portfolio model for an investor, but his/her risk tolerance should significantly reflect the portfolio's components. In contrast, a high risk-tolerant investor might have exposure to stocks or mutual funds of small-cap companies, large-cap growth stocks, some high-yield bonds, and could also look for real estate, international, and other alternative investment options for their portfolio.
And a conservative investor might be inclined to a portfolio with broad-based index funds, large-cap allocation, investment-grade bonds, and a position in high-grade liquid investment options.
In simple words, an individual should minimize exposure to asset classes or securities whose volatility makes them worried and uncomfortable.
How the Time Horizon Affect Portfolio ?
As we talked about risk tolerance, investors should take into consideration the tenure they want to invest in when building a portfolio. In simpler words, investors should go forward with a conservative asset allocation as their goal date approaches, to protect their portfolio's returns up to that day. Moreover, asset allocation in one’s portfolio should be planned on the basis of time horizon. An investor who wants to invest for a long term can consider risky investments which could generate good returns over the long run. And investors with a short horizon can consider investing in relatively stable & less volatile securities and asset classes.
Mutual Fund Portfolio
In the above parts, we talked about the portfolio, but with the growing trend of investing in mutual funds, let’s talk about how an investor can make an ideal portfolio of mutual funds that will give him his desired results. Here are some important steps for the same:
Have a goal with a blueprint:
The starting point should be thinking about why you are investing. The answer can be for retirement, your child’s education, building a house, buying that dream car, etc. So whatever the goal is, one must plan the blueprint which must contain the amount that can be invested monthly or periodically, the time horizon, and risk. This will further assist in finalizing the type of MF and amount to be allocated.
This can be done with the help of a mutual fund advisor who will prepare a plan to achieve your financial goals & requirements.
Decide an Asset Allocation:
Some experts are of the opinion that determining the asset allocation is the most significant step that one will make with respect to his investments. This will help in diversifying the overall portfolio and earn the desired results. Now the question arises, HOW? To get the answer, one must look again at his/her goals, age, risk appetite, and other important things. For instance, If a young investor of 25 years of age is aiming to buy a house 20 years down the lane, he can predominantly go for aggressive equities as he is young & can bear the risks and allocate the rest to debt-based or less volatile options.
Assess your holding and other investments:
An investor must note down all other investments he possesses on a spreadsheet, and check if he is overlapping investments and is diversified enough. He should calculate how much he is invested in them. After doing this exercise, the investor will be able to make a wise decision as he would now know what he is already invested in and what possible options are left now.
Bring it all together:
Now that an investor is well aware of all the aspects and have a rock-solid blueprint, he must contact financial advisors and professionals, do the necessary research, and see what combination of funds is complementing his blueprint and in what manner he should invest in them so that he can finally achieve his goal after a specific tenure.
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