You don’t have to have dozens of stocks in your investment portfolio or trade stocks on a regular basis to have a good investment portfolio. It must have a definite goal. When you know what you need to use it for, when you will need it and how much loss you can afford the choices become easier.
Creating a beginners strategy for building an investment portfolio is actually a strategy of creating a portfolio mix that is affordable, understood, and sustainable throughout challenging times. The aim is to make slow but consistent steps towards a goal that’s important to you.
Identify a clear financial objective before you get started!
There must be a job for every portfolio. It can be for a 30-year retirement, 7 year home purchase, or 15 year education. The length of time you can invest your money and the level of risk that can be taken will depend on the goal.
If you wish to save $40,000 for a home deposit in 8 years, how much must you save each month? You have $8,000 and you will invest $300 per month. That provides you with a quantifiable goal.
Returns on volatile investments should not be a major source of funds for unforeseen expenses. If the market drops 20% on a $20,000 portfolio, it can end up worth $16,000 and the market might not rebound in time for you to cash in.
Determine your risk tolerance level
Risk tolerance is how much loss you’re willing and able to take in order to gain. While you may feel that your feelings are important, so are your finances and time.
Suppose you invest $10,000 in a portfolio that is 70% invested in stocks and experience a 30% decline in the value of that portfolio. Would you continue to contribute, would you stop contributing, or would you sell? Your honest response is a good indicator of what type of portfolio is the right one for you.
Other factors that influence risk tolerance include income stability, emergency savings, debt obligations, family responsibilities, and time horizon. Someone who has 25 years remaining would be considered to have more time to bounce back than someone purchasing a home in four years.
Select what assets are included in your portfolio
Your asset allocation is the ratio of your portfolio invested in stocks, bonds and cash. Stocks have generally greater growth potential, but greater price volatility. Bonds can earn dividends and help smooth returns, but can also decrease in value. Cash is more reliable but can be devalued by inflation.
An investor who is more focused on growth may opt for 80% stocks and 20% bonds. A moderate portfolio could consist of 60% stocks and 40% bonds.
If you invest $5,000 using a 70/30 allocation, $3,500 goes into stocks and $1,500 into bonds. Your mix should reflect your objective, risk tolerance and time horizon.
Build in Diversification
A diversified portfolio is one that is spread across various investments, companies, and countries so that a single investment is not the deciding factor. This is a diversified portfolio of 5 technology stocks, but they can all go down at once.
Assume that you put $6,000 into one company and the stock value declines 50%. You lose $3,000 in your portfolio. If that’s distributed among hundreds of companies in a wide fund, one failure will have a much less pronounced impact.
Diversification does not guarantee no losses, but it can minimize the concentration risk.
Simplify investing with Broad Funds to Keep It Simple
A wide index mutual fund or exchange-traded fund may contain hundreds or thousands of investments in a single purchase.
A basic portfolio could consist of a domestic stock fund, an international stock fund, and a general bond fund. You would invest $1,000 into your portfolio with a 60% weight in stocks and 40% weight in bonds, which would translate to $400 in bonds, $180 in international stocks, and $420 in domestic stocks.
Target-date or balanced funds can take care of asset allocation and rebalancing within the fund. Research the holdings, risk, fees, and strategy before making an investment.
Keep Fees Under Control
Fees are deducted from the amount of money that can be grown. The expense ratio is a percentage of your investment that indicates how much a fund costs you annually.
A 0.10% expense ratio costs about $10 per year on $10,000. Expenses at 1% cost approximately $100. For a $100,000 investment portfolio, the disparity is about $100 versus $1,000 per year.
Be sure to review any trading commissions, account fees, advisory fees or currency conversion fees. Before the money is used it takes 10% off of it from a platform that charges $5 per $50.
Select your Investment Account
The account itself is the storage area and the money, stocks and bonds are the items stored within it. You may be able to have a brokerage account, an employer plan, a retirement account or other tax favored account.
A retirement account might have tax advantages, but have limited early withdrawal options. A regular brokerage account can be more flexible, but dividends and realized gains will be taxable.
If you have a retirement goal 25 years away, a tax-advantaged account could be a priority. If a home is purchased in 6 years, a more flexible account might be feasible.
Buy and sell on a consistent basis
Waiting for the right opportunity can mean that your money remains in your pocket. A regular schedule provides you with a process that isn’t based on prediction.
Now assume that you invest $200 every month. If prices are high, then you will purchase fewer shares. If they are on sale, you purchase more. This strategy is known as dollar cost averaging and isn’t an assured way to make money, but promotes consistency.
If you invest $200 a month at a hypothetical 7% annual return, after 10 years you would have approximately $34,600, and after 20 years you would have approximately $104,000. Actual returns will vary.
Balance Out Of Tune Mixes
Rebalancing refers to reallocating the portfolio back to the desired asset allocation. The rates of return on different investments vary, so the mix changes over time.
Assume you start with $7,000 in stocks and $3,000 in bonds, a 70/30 split. Stocks rise to $8,750 while bonds remain at $3,000. The portfolio is now just under 74 percent stocks and a bit over 26 percent bonds.
Rebalancing is achieved by selling a portion of the over-weighted investment and/or purchasing more of the under-weighted investment or by redirecting new investment to the under-weighted investment. Check tax and transaction expenses prior to selling. Many long-term investors may be satisfied with an annual or bi-annual check.
Avoid Rebuilding the Portfolio After Every Headline
When a stock’s price has dropped precipitously, selling can become a permanent loss, and when a stock is in the midst of an exciting upward trend, buying can be a permanent gain.
If a $12,000 portfolio falls 15%, its value becomes $10,200. It may feel like it is easier to go all in cash, but you’ll need to make a judgement call on when to go back. Not completing a recovery can have negative consequences for future outcomes.
If your goal, time horizon, or financial situation or risk appetite shifts, adjust accordingly, rather than due to one alarming headline.
The Bottom Line
Building an investment portfolio begins with your objective, time horizon and your risk tolerance. The decisions will help you determine your asset allocation, and diversification will help you manage and minimize your reliance on any particular investment.
Maintaining a broad, low-cost (breadth) fund is manageable. Commit to investing regularly, reduce fees, and rebalance back to desired risk level. A straightforward strategy with a long history of success is often superior to an elaborate scheme that is considered dead-on-arrival in the first down-market.
Frequently Asked Questions
What is the number of investments that a beginner should have in his portfolio?
There is no required number. A very diversified fund may include hundreds or thousands of securities, and several stocks may not be enough to assure you are diversified.
What’s a solid starting point for an asset allocation for a novice?
The asset mix that is right for you is influenced by your objective, time frame and risk tolerance. Holders of stocks who have a long time horizon might choose to have more stocks; people who need money more promptly might choose more bonds or cash.
How often is it a good idea to rebalance your investment portfolio?
Many investors check their allocation periodically every six months or 12 months, or when it deviates from the target allocation by a large margin. Look at selling investments to rebalance, after factoring in taxes and trading costs.
Disclaimer:
This article is for general educational purposes only and does not provide personalized financial, investment, tax, or legal advice. Investments can lose value, diversification does not guarantee a profit, and tax rules and account options vary by country.
