How to Build
an Investment
Portfolio
Building an investment portfolio is about more than selecting individual investments. In fact, in many ways, it is like cooking a great meal. You need the right ingredients, the right proportions, and the patience to let it all come together. Once you’ve got the recipe right, you will have a portfolio that balances risk, return, and time horizon while staying aligned with your financial goals.
How to Diversify Your Portfolio
There is no single approach to portfolio diversification that works for everyone. Effective diversification requires personalization. You need to understand the strengths and gaps in your portfolio and how they align with your financial goals. Factors such as your risk appetite, investment horizon, and income level all play a key role in your strategy.
1
Assess your risk appetite. Before you decide where to invest your money, you need to answer one simple question – how much risk are you actually comfortable with? Your risk appetite is the backbone of your entire portfolio diversification strategy. It determines how much you invest in stocks, bonds, cash, and other asset classes. Typically, portfolios can be either of the following:
- Aggressive: These may contain around 80% stocks, and 20% bonds, and cash.
- Moderate: These may contain around 60% stocks, and 40% bonds, and cash.
- Conservative: These may contain around 40% stocks, and 60% bonds, and cash.
2
Focus on diversifying within asset classes, not just between them. Most people think diversification is about spreading money across stocks, bonds, and cash. But true portfolio diversification also happens inside each asset class.
Let’s start with stocks. You can spread your stock investments across different types of companies, market capitalizations, sectors, investment styles, and geographic diversification.
3
Consider index funds. If you like the idea of portfolio diversification but do not want to spend your time browsing through companies and sectors, index funds can be a great option. Instead of buying individual stocks one by one, you buy into an entire market or segment of the market at once with an index fund.
Index funds track a benchmark and invest in the same stocks and in the same weightings as the benchmark, and are managed by a fund manager, who ensures professional expertise. As a result, this approach is much simpler than building a portfolio yourself. The fund would automatically spread your money across companies, potentially helping reduce risk.
4
Do not be shy about exploring options outside the usual. If you are open to it and your risk appetite allows, you can also consider alternative investments to further diversify your portfolio. These include assets such as real estate, hedge funds, venture capital, or collectibles.
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How to Rebalance Your Portfolio
Over time, market movements can shift your asset allocation away from your target. Rebalancing involves realigning your portfolio to maintain your desired allocation through various strategies, each with its unique approach and benefits:
The most straightforward method of rebalancing involves selling assets that have exceeded their target allocation and buying those that are underrepresented. This direct trade ensures that your portfolio adheres to its original risk and return profile by realigning it with your strategic goals.
An efficient way to rebalance an investment portfolio without incurring transaction costs is to use new contributions. As you add money to your investment accounts, direct these new funds towards purchasing underweighted assets. This method helps maintain the desired asset balance and avoid the costs of selling overrepresented assets.
Many investors opt for automated rebalancing through robo-advisors or financial platforms. These services routinely adjust your portfolio to maintain target allocations, often as part of their management offering. This automation ensures continuous alignment with investment goals and can be particularly beneficial for those who prefer a hands-off approach to their investment strategy.
How to Decide the Right Asset Allocation for Your Portfolio by Age
In your 20s and 30s
This is a phase where you start planning for long-term goals, such as retirement or college education funds for your children. The investment horizon is longer, and your risk appetite is higher. However, you may not have as many funds to invest at this age, as you would be just beginning your career. You could also have student loans to repay. Therefore, exposing yourself to too much risk can lead to stress and anxiety.
What you should do:
- Maximize your contributions to tax-advantaged accounts, such as 401(k)s, IRAs, and other retirement accounts.
- Consider investing in mutual funds, direct equity, exchange-traded funds, and corporate bonds.
- Maintain an emergency cash reserve to avoid dipping into your savings.
In your 40s and 50s
During this phase, you may be on a higher pay scale, earning the highest salary of your career. However, your financial liabilities and expenses will also increase. Loans, mortgages, taxes, school or college fees, utility bills, lifestyle choices, etc., can add up to a lot. Nevertheless, you still have many years before you retire, which keeps your risk profile high and gives you time to make a profit and overcome potential losses.
What you should do:
- Aim to keep a high proportion of stocks in your portfolio.
- Gradually increase your fixed income exposure.
- Focus on wealth accumulation and risk management.
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In your 60s
This is the closest you can be to retirement. This stage in your life can be full of personal and professional changes. Hence, it may be advisable to stick to stable fixed-income assets, such as bonds, along with cash. If you are over 60, it may also be advisable to keep your 401(k) retirement account concentrated in bonds and cash.
What you should do:
- Prioritize allocation to stable fixed-income assets.
- Minimize your exposure to market volatility.
- Switch focus to capital preservation.
In retirement
Contrary to popular perception, retirement is not a time when you should be averse to the idea of investing in stocks. Considering the fact that your retirement can last for many years, a mix of stocks, fixed income assets, and cash can offer you the necessary level of growth.
What you should do:
- Keep a modest allocation to equities to support long-term growth.
- Increase allocation to bonds and cash for stability and income.
- Focus on capital preservation while still allowing for growth.
- Ensure the portfolio can support regular withdrawals without depleting savings too quickly.
Review and Adjust Your Portfolio Regularly
Regular portfolio reviews are essential to ensure your investment strategy remains aligned with your financial goals and market conditions. As you age, your financial situation, risk tolerance, and market dynamics can change, necessitating adjustments to your portfolio. Regular reviews help you stay on top of these changes and make necessary tweaks to optimize performance and manage risks.
Adjusting your strategy based on market conditions and personal circumstances is widely recommended and effective. For instance, during periods of economic uncertainty or market volatility, you might need to rebalance your portfolio to maintain your desired asset allocation. This could involve shifting funds from more volatile investments to more stable ones or vice versa, depending on your risk tolerance and financial needs. Personal circumstances, such as changes in health, unexpected expenses, or alterations in income streams, also require adjustments to your investment strategy.
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Calculate NowFrequently Asked Questions
No, diversification can’t guarantee higher returns. Nothing in investing can. Diversification reduces risk by spreading your money across different assets. This, in turn, can potentially lead to better outcomes over time.
Not necessarily. If you keep things simple and use index funds, you can build a reasonably diversified portfolio on your own. But if you are adding multiple asset classes, alternative investments, etc., expert guidance can help.
There is no one-size-fits-all allocation. However:
- Aggressive: 80% stocks, 20% bonds/cash
- Moderate: 60% stocks, 40% bonds/cash
- Conservative: 40% stocks, 60% bonds/cash
You should review your portfolio:
- At least once a year
- After major life events
- During significant market changes
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