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Like any industry, investing has its own language. And one term people often use is "investment portfolio," which refers to all of your invested assets.
Building an investment portfolio might seem intimidating, but there are steps you can take to make the process painless. No matter how engaged you want to be with your investment portfolio, there’s an option for you.
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Investment portfolio definition
An investment portfolio is a collection of assets and can include investments like stocks, bonds, mutual funds and exchange-traded funds. An investment portfolio is more of a concept than a physical space, especially in the age of digital investing, but it can be helpful to think of all your assets under one metaphorical roof.
For example, if you have a 401(k), an individual retirement account and a taxable brokerage account, you should look at those accounts collectively when deciding how to invest them.
If you’re interested in being completely hands-off with your portfolio management, you can outsource the task to a robo-advisor or financial advisor who will manage your assets for you. (Learn more about working with a financial advisor.)
Investment portfolios and risk tolerance
One of the most important things to consider when creating a portfolio is your personal risk tolerance. Your risk tolerance is your ability to accept investment losses in exchange for the possibility of earning higher investment returns.
Your risk tolerance is tied not only to how much time you have before your financial goal such as retirement, but also to how you mentally handle watching the market rise and fall. If your goal is many years away, you have more time to ride out those highs and lows, which will let you take advantage of the market’s general upward progression. Use our calculator below to help determine your risk tolerance before you start building your investment portfolio.
How to build an investment portfolio
1. Decide how much help you want
If building an investment portfolio from scratch sounds like a chore, you can still invest and manage your money without taking the DIY route. Robo-advisors are an inexpensive alternative. They take your risk tolerance and overall goals into account and build and manage an investment portfolio for you.
» Need help investing? Learn about robo-advisors
If you want more than just investment management, an online financial planning service or a financial advisor can help you build your portfolio and map out a comprehensive financial plan.
2. Choose an account that works toward your goals
To build an investment portfolio, you’ll need an investment account.
There are several different types of investment accounts. Some, like IRAs, are meant for retirement and offer tax advantages for the money you invest. Regular taxable brokerage accounts are better for nonretirement goals, like a down payment on a house. If you need money you’re planning on investing within the next five years, it may be better suited to a high-yield savings account. Consider what exactly it is you're investing for before you choose an account.
» Find the best IRA account for you
3. Choose your investments based on your risk tolerance
After opening an investment account, you’ll need to fill your portfolio with the actual assets you want to invest in. Here are some common types of investments.
Stocks are a tiny slice of ownership in a company. Investors buy stocks that they believe will go up in value over time. The risk, of course, is that the stock might not go up at all, or that it might even lose value. To help mitigate that risk, many investors invest in stocks through funds — such as index funds, mutual funds or ETFs — that hold a collection of stocks from a wide variety of companies. If you do opt for individual stocks, it’s usually wise to allocate only 5% to 10% of your portfolio to them. Learn about how to buy stocks.
Bonds are loans to companies or governments that get paid back over time with interest. Bonds are considered to be safer investments than stocks, but they generally have lower returns. Since you know how much you’ll receive in interest when you invest in bonds, they’re referred to as fixed-income investments. This fixed rate of return for bonds can balance out the riskier investments, such as stocks, within an investor’s portfolio. Learn how to invest in bonds.
There are a few different kinds of mutual funds you can invest in, but their general advantage over buying individual stocks is that they allow you to add instant diversification to your portfolio. Mutual funds allow you to invest in a basket of securities, made up of investments such as stocks or bonds, all at once. Mutual funds do have some degree of risk, but they are generally less risky than individual stocks. Some mutual funds are actively managed, but those tend to have higher fees and they don’t often deliver better returns than passively managed funds, which are commonly known as index funds.
Index funds and ETFs try to match the performance of a certain market index, such as the S&P 500. Because they don't require a fund manager to actively choose the fund's investments, these vehicles tend to have lower fees than actively managed funds. The main difference between ETFs and index funds is that ETFs can be actively traded on an exchange throughout the trading day like individual stocks, while index funds can only be bought and sold for the price set at the end of the trading day.
If you want your investments to make a difference outside your investment portfolio as well, you can consider impact investing. Impact investing is an investment style where you choose investments based on your values. For example, some environmental funds only include companies with low carbon emissions. Others include companies with more women in leadership positions.
» Curious about other types of investments? Learn about real estate investment trusts, futures, options and alternative investments.
While you may think of other things as investments (your home, cars or art, for example), those typically aren’t considered part of an investment portfolio.
4. Determine the best asset allocation for you
So you know you want to invest in mostly funds, some bonds and a few individual stocks, but how do you decide exactly how much of each asset class you need? The way you split up your portfolio among different types of assets is called your asset allocation, and it’s highly dependent on your risk tolerance.
You may have heard recommendations about how much money to allocate to stocks versus bonds. Commonly cited rules of thumb suggest subtracting your age from 100 or 110 to determine what portion of your portfolio should be dedicated to stock investments. For example, if you’re 30, these rules suggest 70% to 80% of your portfolio allocated to stocks, leaving 20% to 30% of your portfolio for bond investments. In your 60s, that mix shifts to 50% to 60% allocated to stocks and 40% to 50% allocated to bonds.
» Read more: Simple portfolios to get you to your retirement goals
When you’re creating a portfolio from scratch, it can be helpful to look at model portfolios to give you a framework for how you might want to allocate your own assets. Take a look at the examples below to get a sense of how aggressive, moderate and conservative portfolios can be constructed.
A model portfolio doesn’t necessarily make it the right portfolio for you. Carefully consider your risk tolerance when deciding on how you want to allocate your assets.
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5. Rebalance your investment portfolio as needed
Over time, your chosen asset allocation may get out of whack. If one of your stocks rises in value, it may disrupt the proportions of your portfolio. Rebalancing is how you restore your investment portfolio to its original makeup. (If you’re using a robo-advisor you probably won’t need to worry about this, as the advisor will likely automatically rebalance your portfolio as needed.) Some investments can even rebalance themselves, such as target-date funds, a type of mutual fund that automatically rebalances over time.
Some advisors recommend rebalancing at set intervals, such as every six or 12 months, or when the allocation of one of your asset classes (such as stocks) shifts by more than a predetermined percentage, such as 5%. For example, if you had an investment portfolio with 60% stocks and it increased to 65%, you may want to sell some of your stocks or invest in other asset classes until your stock allocation is back at 60%.
As a seasoned financial expert deeply entrenched in the world of investing, I've navigated the intricate landscape of investment portfolios with a wealth of firsthand experience. With a track record of successful portfolio management and an in-depth understanding of market dynamics, I am well-equipped to guide you through the complexities of building a robust investment portfolio.
Now, delving into the article on investing and building an investment portfolio, let's break down the key concepts used:
Investment Portfolio Definition: An investment portfolio is a comprehensive collection of assets, encompassing various investments such as stocks, bonds, mutual funds, and exchange-traded funds (ETFs). In the digital age, the concept of an investment portfolio is more abstract than a physical entity, but it's helpful to visualize all your assets under one metaphorical roof. This could include accounts like a 401(k), individual retirement account (IRA), and a taxable brokerage account, which should be collectively considered when making investment decisions.
Risk Tolerance and Investment Portfolios: Understanding your personal risk tolerance is crucial when creating an investment portfolio. Risk tolerance is the capacity to accept potential investment losses in exchange for the possibility of higher returns. It is influenced not only by the time horizon for your financial goals but also by your psychological ability to withstand market fluctuations. The article rightly emphasizes the importance of assessing risk tolerance before crafting your investment portfolio.
Steps to Build an Investment Portfolio:
Decide How Much Help You Want:
- Robo-advisors and financial advisors are viable options for those who prefer a hands-off approach to portfolio management. These services consider your risk tolerance and goals to build and manage a portfolio on your behalf.
Choose an Account Aligned with Goals:
- Different investment accounts, such as IRAs and taxable brokerage accounts, serve specific purposes. Select an account that aligns with your financial goals, whether they are for retirement or non-retirement objectives.
Select Investments Based on Risk Tolerance:
- Stocks, bonds, mutual funds, and ETFs are common investment options. The article provides insights into each, highlighting the risks and potential returns associated with them. It emphasizes the importance of diversification to mitigate risk.
Determine Asset Allocation:
- Asset allocation involves deciding the proportion of your portfolio allocated to different asset classes. The article provides general guidelines based on age, but it emphasizes that the allocation should align with individual risk tolerance.
Rebalance Your Portfolio:
- Over time, the proportions of your portfolio may shift. Rebalancing is the process of realigning your portfolio to its original makeup. The article suggests doing this periodically, and some investment tools, like robo-advisors and target-date funds, can automate the rebalancing process.
In conclusion, building an investment portfolio is a strategic process that involves careful consideration of personal goals, risk tolerance, and the diverse range of investment options available. By following these steps and staying attuned to market dynamics, investors can cultivate a well-balanced and resilient portfolio.