DEFINITION:
A portfolio is a collection of financial investments, such as stocks, bonds, cash, or cash equivalents, real estate, or other wide range of investments.
Understanding a portfolio
A portfolio is an aggregate of your financial assets, providing an overview of how you’ve decided to allocate your money. The general audience tends to believe that a portfolio is a collection that only consists of stocks, bonds, and cash. However, more broadly, it can include other assets, such as gold, art or etc. Different factors influence how you create your portfolio, but most of all, your willingness to take risks and your time horizon.
EXAMPLE
In case a person would like to invest $10,000 and divide between different asset types. First, it’s necessary to purchase $2500 in Microsoft stock and $1500 in Netflix. If they’re worried about the performance of just two companies, they could extend their selections and choose to invest in some other companies’ stocks. The investor could also purchase municipal bonds or an index fund.
What is a portfolio?
A portfolio is a 30,000-foot view of your investments. It’s a big picture that gives you a perspective to understand how the core elements of your assets look like, either stock, bonds, or any other financial asset you own. It is best that your portfolio could help you to achieve the best possible return bearing in mind your risk tolerance. The combination of your assets in the portfolio should comprise both your financial needs and for how long you would prefer to own each of the assets.
Portfolios could have different shapes and forms., but sometimes they could consist of only one type of asset class, like stocks or bonds. Nevertheless, there are recommendations and common practices for what to include in your portfolio. These depend on your earnings, your lifestyle, how risky you are, or even your retirement plans. Also, when a person is discussing an investment portfolio, usually they don’t include cars or houses.
The main purpose of having a portfolio
Portfolios provide a window into your financial life. They’re meant to help you monitor and manage your investments.
If you need, you could diversify your assets, mixing them between different stocks, bonds, and other purposes. You could also understand if your chosen strategy is working for you or not, and then either sell one type of asset or the opposite to buy more from the other asset class. People also use target allocations in case they want to plan for different strategies. A financial planner could help you to decide what percentage to invest in stocks or bonds.
Important aspects while building a portfolio
Building a simple portfolio can be as easy as just buying a few stocks. That’s why most people use this approach. Once you decide to build a more intentional portfolio where returns and risks are optimized, there appears a need to include a variety of assets. Such a mix that you choose is called an asset allocation.
Let’s have a look at the three main ways to build your portfolio:
1. Rely on your own views and do everything by yourself.
2. Investments in managed mutual fund or exchange-traded fund.
3. To address to a financial advisor, someone who could choose everything for you, who would provide some advice on investing.
Two crucial aspects of building your portfolio:
1. Time horizon.
2. Risk tolerance
To determine these two parameters could be very useful, as that would help you to decide on the types of investments you should rely on.
Risky with a long time horizon
Aggressive investors usually choose this type of strategy and tend to buy stocks and real estate. Besides being more volatile and riskier, this strategy presents greater upside.
Not-so-risky with a short time horizon
Conservative investors always choose certain financial stability that goes in line with expectable returns. They invest more of their money in income-oriented investments: bonds or dividend-paying stocks of larger, more established companies.
What about a portfolio rebalancing?
With time, the price of some assets will rise, and others will fall. As a result, your asset allocation is likely to change. For instance, if stocks have been performing well enough compared to other assets, your portfolio might have a higher concentration in stocks and lower in other assets.
Rebalancing implies a certain shift of your portfolio back to the initial target allocation (or also just a revision of those targets). Once you keep in mind your initial strategy, you could always sell some extra or buy in some areas where’s underweight. Rebalancing is a good tool to keep your portfolio up with your risk tolerance.
A few words about a diversified portfolio
A diversified portfolio is used to manage risks by spreading your investments across different types of assets. Usually, diversification helps you to reduce volatility and smooth returns. It is certainly wrong to allocate all your money into a single asset class, as that would put your portfolio at an extreme level of risk. For example, it would be much safer to have both stocks and bonds in case of an unpredictable stock market crash.
Most bonds are not to fall as dramatically as stocks—and bonds usually provide a predictable source of income. You could minimize your losses once you’ve diversified your portfolio. Of course, it is not always a rule, as in some cases, under different circumstances, one could experience losses across all the board.
You need to be smart enough to identify assets that aren’t dependent on one another, and eventually, those that won’t fall together. When one of the assets performs poorly, the other could counterbalance it. The same story would be when you’re trying to plan your vacation in an exotic place, once the weather is fine, you would go and explore nature, but in a case when it’s a thunderstorm, you would rather bring your favorite boardgames in advance to stay indoors. By that, you would have diversification in action.
One should not forget that diversification doesn’t prevent losses, but it could help to limit it. When you build a diversified portfolio, you have to use a mix of stocks, bonds, cash or etc.
Diversification doesn’t prevent losses, but it can help limit them. Building a diversified portfolio typically involves a mix of stocks, bonds, and cash, and if you add real estate or, for example, gold to your portfolio, you will only strengthen it. In case you prefer to invest only in stocks, a half-century ago, researchers suggested that as few as ten stocks could help in the pursuit of stable diversification; however, nowadays, you would need more to have a truly diversified portfolio.
Even if you decide to only invest in stocks, you can achieve a measure of diversification simply by owning more than one stock. In the 1960s, stock market researchers found that as few as ten stocks could help in the pursuit of diversification. That said, in contemporary times, many believe it takes more stocks to build a truly diversified portfolio. You could also try to diversify via acquiring stocks of both old, well-established, dividend-oriented companies and growth-oriented ones.
The portfolio might be tricky.
It is important to remember that no single asset allocation could be perfect for everybody. What would be best for one type of investor might never be useful for the others. Depending on the situation and one’s goals, everyone should find their best way to create an investment portfolio. Besides the ordinary risks of investing, there’re some others that require more deep research and the help of professional advisers.