What Is an Investment Portfolio and How To Build a Good One?
Often you hear that diversification in investing is essential. Why are people concerned with this? As you've read before, don't put all your eggs in one basket when considering various investment portfolio examples.
Building a successful investment portfolio can be intimidating, but it can be done simply and efficiently with model portfolios. Risk-averse investors will stick to safer investments whilst those with a higher risk tolerance will build an aggressive portfolio with other asset classes.
A well-diversified portfolio should be balancing risk through asset allocation. This aims to provide some level of protection from the risk of complete losses and preservation of capital, particularly during market downturns.
In this article, we present an example of a balanced portfolio across asset classes and an illustration of stock allocation for your brokerage account. You can also download our eBook “The Ultimate Cheat Sheet on Stock Market Investing”.
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Investment portfolio definition
An investment portfolio is a collection of assets, such as stocks, gold, bonds, mutual funds, and index funds, that you are invested in. A good investment portfolio should include different types of investments so that it can match your risk tolerance, time horizon, and investment objectives.
A financial advisor can help you decide on the recommended investment portfolios for your situation, but we'll start here with some basic guidelines.
There is no one-size-fits-all when it comes to asset allocation, although the vast majority of investors tend to start with individual stocks. The arrival of no-fee trading platforms, which also offer the possibility to own fractional shares, has made investing in stocks and bonds easier than ever before.
Why is diversification important?
The very definition of diversification suggests that it reduces risk. It gives you choices in how you invest your hard-earned cash. When you invest and spread your money across different asset classes, you reduce the overall risk that multiple investments will lose value at the same time.
Of course, no investment strategy is 100% protected from loss, so diversification alone doesn't guarantee gains - it just mitigates the risk posed by any one single asset's volatility.
This way, if one area of your growth portfolio suffers a crisis (eg. individual stocks), then other areas of your income portfolio (eg. bonds) may not be affected as severely. Similarly, if one of the investments loses money, then it won't likely wipe out your whole investment returns because the losses are being offset by other assets in your portfolio doing well.
Depending on your investment style, diversification allows you to explore other investments you may not be familiar with or comfortable investing in. For instance, those who favor safer investments could still allocate 2-3% of their portfolio toward cryptocurrencies or emerging markets. Or those heavily invested in the stock market could put some money in real estate or treasury bills (bonds). It is also worth checking if an asset class presents tax advantages.
What makes a portfolio well-diversified?
Diversification can be done in several different ways: by asset class, security type, market cap, geography or technology, or by industry. Each way provides its unique benefit when it comes to managing risk.
Within each category, there are also other considerations: value versus growth investing (growth stocks tend to do better over time, but they're also riskier investments); domestic versus international investing; small-cap versus large-cap (small caps generally have more room for growth but bring more volatility), etc...
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Investment portfolio examples
All investment portfolios come with their advantages and drawbacks. You may have read about building a 60/40 portfolio, consisting of 60% invested in the stock market and 40% in fixed-income assets such as bonds or mutual funds.
We think this is not diversified enough, and having so much allocated to bonds should be for the most conservative portfolios in our opinion.
What do you think about this diversified investment portfolio idea? Read on for insights on this investment style.
What is a good investment portfolio?
Ideally, it should contain multiple investment products; which is what we aimed to achieve with the above portfolio sample. Some context needs to be added to any model portfolio; the above investment portfolio could be suited to you if you agree with the following statements:
Long-term time horizon (10 years+) and more than 15 years away from retirement age
Medium to high-risk tolerance
Have emergency funds in savings accounts
Invest money you are prepared to lose
How should I structure my investment portfolio?
Achieving your ideal investment portfolio will take years - and this is OK. If you are in it for the long term, one investment at a time will get you there. With so many asset classes to invest in, from fixed-income investments to real estate, commodities to index funds, and individual stocks to actively managed funds, you might be eager to invest in everything that caught your eye but remember your investing goals.
Don't buy asset classes you do not understand though, just for the sake of diversifying. Warren Buffett, arguably one of the greatest investors of all time, often spoke somewhat against diversification with quotes such as "Diversification may preserve wealth, but concentration builds wealth."
The bottom line is: this is your money, your strategy, and your choices. When investing becomes too confusing, take a step back and remember why you invested in the first place. When it ceases being fun and your investment returns stop you from sleeping at night, then it's time to speak to a financial advisor for guidance.
If you are unable to allocate money to invest, you could read The 50/30/20 Rule: How to Budget your Money more Efficiently
Components of a diversified portfolio: multiple asset classes
Let's explore some asset allocation of the Control All Finances growth portfolio example:
60% Stocks & Real Estate Investment Trusts
Stocks represent the largest part of our investment portfolio sample, which is suited to those willing to take more risk, with a 10-year+ time horizon. Over the past century, the stock market has provided investors with the highest returns when compared to all other types of investments.
People unfamiliar with the stock market often believe that it is ''too risky''. Stocks are seen as riskier compared to most investments since their volatility is very rapid and can decrease rapidly. But you can have a more cautious stock portfolio if you pick stocks from established large-cap companies or dividend aristocrats for example. This doesn't mean that it will not go down at times, but you are unlikely to lose all the money invested in these.
Whilst you cannot base an investment on past performances, stocks expected returns over the long term are high.
What should my stock portfolio look like?
A diversified mix of companies is essential in a stock portfolio, as illustrated in the second pie chart. You can really experiment with diversification when choosing stocks. You can vary your stock selection by:
Market Capitalization: small-cap stocks, mid-cap stocks, large-cap stocks
Sector: Communication Services, Consumer Discretionary, Consumer Staples, Energy, Financial, Healthcare, Industrial, Materials, Real Estate Investment Trusts (REITs), Technology, Utilities
Geography: US stocks, International stocks
Company's growth cycle: IPO stocks, Growth stocks, Value stocks
Dividend payments: Dividend-paying stocks and non-dividend stocks
Perceived quality level: ESG stocks, Blue chip stocks, Penny stocks
Exchange-Traded Funds (ETFs) offer many of the benefits of mutual funds, but they can also be traded more flexibly.
Much like stocks, ETFs can be bought and sold through an online trading platform and held in a taxable brokerage account. They can be structured to track the price of a particular commodity or market index (index funds), or they can be designed to follow specific investment strategies.
One of the most popular stock indexes is the Standard and Poor's 500 (S&P 500), which is a stock index tracking the performance of the 500 largest companies listed on stock exchanges in the U.S. When you purchase an S&P 500 ETF, you are effectively investing in all 500 companies - instant diversification!
You could replace the ETF share of our sample portfolio with a mutual fund or index fund. Either way, those not willing to go through individual companies' annual reports will find comfort in ETFs.
7.5% Bonds or Mutual Funds
Bonds are generally seen as safe and less volatile since they can offer fixed-rate returns. Moreover, they are (usually) a buffer against fluctuations in the overall market.
A disadvantage of this model can mean lower returns on investment. Bonds can also be invested in through mutual funds or in target date funds.
Alternatively, if your bank offers a generous interest on savings accounts, you could replace bonds and/or mutual funds by having their cash equivalents in a high-yield savings account.
Today, investors buy gold as a hedge against political unrest and inflation because of its low correlation with other asset classes. Many top investment advisers also recommend portfolios be composed of a commodity such as gold to lower risk.
But no investment is perfect. If you take 2022, gold was flat through the year, down only 1% in nominal terms. The whole point of gold is to hedge inflation and store value, so you'd hope that its price would have increased along with the rate of inflation. But with inflation topping 9% in the US in 2022, gold's price actually moved inverse to inflation...
Gold can be invested in through a variety of methods, such as bullion (i.e., gold bars), mutual funds, futures contracts, mining companies, and jewelry.
As with stocks, nowadays you can buy and secure gold with the tap of a finger. Online platforms such as Vaulted lets you invest in gold effortlessly. Through the Vaulted app, you invest in 99.99% pure gold kilo bars manufactured by the Royal Canadian Mint and certified Conflict-Free. Get started today with $10.
Whatever your opinion is on cryptocurrencies, if you aim to be as diversified as our illustration, then Bitcoin and other crypto currencies have their place in your portfolio.
5 percent may be considered on the high side considering crypto's volatility, so adapt it to a level you are comfortable with, based on the size of your portfolio.
Many investors, such as myself, were discounting Bitcoin and all cryptos. But seeing their constant rise (and subsequent fall) in the last few years, I too joined in, simply for fear of missing out (FOMO)...
You can read more here 6 Facts Nobody Told You About Crypto Payment
5% Alternative Assets
We conclude our asset allocation example with alternative assets. If you are beginning your investing journey, perhaps you wouldn't start there; but it is a fascinating, wide-ranging category worth looking into for your investment portfolios.
Not all alternative assets are created equal. To get original, honest, and insightful research on 35 types of alternative investments, we highly recommend subscribing to the Alt Assets Newsletter.
Think about it, you might already have some alternative assets at home. If so, it is wise getting them professionally appraised or add value to them with restoration for example. Include these when considering your overall portfolio value.
Diversification is the practice of spreading your investments across different kinds of assets and markets. If you're investing in stocks, bonds, and cash, that's diversification. If you spread your money across a variety of industries, or between domestic and international companies, you're diversifying further.
The goal is to reduce risk - if all of your money is in one stock or one industry, then a downturn in that market will take everything with it.
Younger investors can afford to have riskier investments in their portfolio, whilst those closer to retirement need to exercise caution. In both cases though, a solid portfolio needs to be diversified.
Ultimately, it is up to individual investors to choose which of these investment portfolio ideas is suitable for any given situation. Don't let yourself be talked into investing in something you do not understand. We recommend starting with small investments to see if the methodology is a fit for your own risk tolerance.
The goal, of course, is to create a portfolio that provides an acceptable rate of return on your investment capital while maintaining risk at an appropriate level. There's no guarantee that all pieces will work out as you'd planned, but arming yourself with as much information as possible is one way to help mitigate the risk.
In times of strong economic growth, every investment seems to go up and everybody enjoys seeing their portfolio grow. When hard times hit though, you'll be pleased to have diversified your asset classes!
What is your favorite asset class? What are your investment predictions for the next 6 months? What are your thoughts on our sample portfolio? We'd love your comments down below!
No Financial Advice. This article does not provide financial advice and has been prepared without taking into account any person’s investment objectives, financial situation, risk tolerance, or particular needs. eToro (Europe) Ltd., is a Financial Services Company authorised and regulated by the Cyprus Securities Exchange Commission (CySEC) under the license # 109/10. eToro (UK) Ltd. is authorised and regulated by the Financial Conduct Authority (FCA) under the license FRN 583263. eToro is a multi-asset platform which offers both investing in stocks and cryptoassets, as well as trading CFD assets. CFDs are complex instruments and come with a high risk of losing money rapidly due to leverage. 79% of retail investor accounts lose money when trading CFDs with this provider. You should consider whether you understand how CFDs work and whether you can afford to take the high risk of losing your money. Zero commission stock investing is available to all eToro users, excluding the US. Your capital is at risk. Other fees may apply. For more information, visit etoro.com/trading/fees
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