A solid and diversified investment portfolio is like the holy grail of investing. It rewards the investor with beautiful returns while keeping risk in check. Legendary investor Benjamin Graham defined an investment as “an operation in which, upon thorough analysis, promises safety of principal and adequate returns”.
That said, let’s explore:
- What is an investment portfolio?
- What types of strategies can an investor use?
- How can I build an investment portfolio?
What is an investment portfolio?
An investment portfolio comprises all the assets that an investor owns. Some assets are bought with the intention of use, such as a house or car, while others as a means of generating future returns like stocks and bonds.
The list of asset class types is frankly endless. But some of the most common include:
- Stocks and shares
- Real estate
- Exchange-traded fund
- Mutual fund
- Cash and equivalents.
At the heart of every portfolio is the concept of capital preservation and growth. With that in mind, let’s look at the different types of portfolios.
What are the types of portfolios?
In considering investment portfolios, there are different forms of classification. It’s possible to describe a portfolio based on its contents or the owner’s risk tolerance.
Some examples of the former include:
- ESG-Only Investments
- Impact-Only Investments
- Sin Stocks (Oil, Tobacco, Gaming, and Alcohol)
- Dividend Aristocrats
Some examples of the latter include:
- Aggressive – This type of portfolio is designed to maximise investment returns across a range of different positions. This typically results in investment risk being cast to the wayside in the pursuit of capital growth. These decisions can generate enormous wealth if successful. However, should an investment fail to live up to expectations, wealth will likely be destroyed rather than created.
- Income – This investment portfolio is constructed in such a way that it will bring in passive income to the investor. Often this style of investing usually surrounds mature dividend-paying companies that can deliver reliable passive income.
- Defensive – The focus here is capital preservation. To achieve this, more stable asset classes are bought. In building a defensive investment portfolio, the investor could look for stocks or corporate bonds in established mature businesses. The returns are often left wanting. However, during times of economic distress, these portfolios are often less exposed to stock market volatility.
- Speculative – This portfolio is closer to gambling. As Benjamin Graham was quoted earlier, the speculators’ returns are less guaranteed. The portfolio could be comprised of IPO stocks, stocks billed for takeover and their likes.
- Hybrid – This tries to achieve balance by using different strategies. The investor is aggressive, defensive, speculative, and income-seeking at the same time.
How to build an Investment Portfolio?
In building a portfolio, the investor should try to achieve as much diversification as possible yet not spread the investment too thinly. Below are things to consider during the investment portfolio construction phase:
- Keep financial goals in mind – Every investor has a different financial goal that makes certain investments unsuitable. By keeping their financial goals in mind, an individual can avoid taking on unnecessary risks to achieve their objective.
- Asset allocation – This is the weighting decision every investor has to make. How much of each asset do they want to own? This is not an easy question to answer, and there are a lot of complicated strategies, such as Modern Portfolio Theory, that attempt to answer this question. The easiest method to adopt is an equal-weighted approach, where the initial investment into each asset should be the same, with slight adjustments made depending on the level of risk associated with a particular asset.
- Risk tolerance – Equally important in building an investment portfolio is knowing how much risk an investor is willing to accept. An investor could be an aggressive risk taker or simply someone trying to protect the wealth they already have. In most cases, the latter has no business buying risk penny stocks.
- Keep an emergency fund – Today, this is even more important. The last position any investor wants to be in is being forced to sell an investment when prices are low. By keeping some cash on the side to meet real-life expenses, investors can mitigate this risk.
Concluding thoughts on building an investment portfolio
It’s worth repeating that diversification and asset allocation are what could make the difference between a winning and losing investment portfolio. Today the capital requirements for starting a portfolio are very low. After all, with multiple brokers offering commission-free trading, an individual with as little as £20 can get started.
However, portfolio management is an ongoing process that requires a steady amount of attention. For some individuals who are unwilling, unable, or uncertain about building an investment portfolio, speaking to an expert investment manager is likely a prudent move.
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Prosper Ambaka does not own shares in any of the companies mentioned. The Money Cog has no position in any of the companies mentioned. Views expressed on the companies and assets mentioned in this article are those of the writer and therefore may differ from the opinions of analysts in The Money Cog Premium services.