An investment portfolio is a basket of assets that typically include stocks, bonds, cash, real estate and more. Investors generally aim for a return by diversifying these securities in a way that reflects their risk tolerance and financial goals. There are many different types of investment portfolios, as some are built into 401(k)s, IRAs and annuities, while others exist on their own through a brokerage or financial advisory firm. For more hands-on help, consider working with a financial advisor who can help create a financial plan for your investments.
Determine Your Investment Portfolio’s Asset Allocation
If you’re looking to invest, you’ll want to become familiar with the concept of asset allocation. This describes how you break down an investment portfolio by asset class percentage.
For starters, an asset class is basically a category of various types of securities. For example, stocks are a specific asset class, as they’re uniquely shares through which you own a slice of a company. Meanwhile, the fixed-income asset class can include bonds and certificates of deposit (CDs).
Below, we provide seven more examples of different securities and asset classes you can build an investment portfolio with:
- Exchange-traded funds (ETFs)
- Mutual funds
- Bond funds
- Real estate investment trusts (REITs)
- Annuities
- Options
- Real estate
While you can just randomly dump these into an investment portfolio and hope for returns, an asset allocation attempts to plan things out very specifically. For this, diversification is key, and your asset allocation should adhere to your comfort level with investment risk.
Diversifying involves building a plan around what percentages you’ll invest your assets within your portfolio across various types of investments. These are typically chosen based on what your risk tolerance is. For example, those who are open to riskier investments with the hopes of higher returns, may have their assets invested in a higher percentage of stocks. On the flip side, a more risk-averse investor may focus more on bonds and fixed-income securities that are safer, with less returns, most likely.
Create an Investment Portfolio Using Your Risk Tolerance
Risk is the potential for your investments to lose money when the market or a particular asset class doesn’t perform well. There is always a degree of risk when you invest. If you absolutely cannot afford to lose your money, you might want to consider putting it into a savings account or the best CD you can find. The FDIC insures both of these. That means you won’t lose all your money the way you might with a stock.
Your risk tolerance is the amount of variability that you can handle with your investments. In other words, it reflects how well you can stomach the ups and downs that come with any investment. This is what investors call market volatility.
If you need your money in a few years and can’t afford to lose any of it, you have a low-risk capacity. This means you will likely not recover from a major downturn in the market. Because of that, you’ll also likely be unwilling to to bear that risk and have a low risk tolerance.
On the other hand, someone who won’t need his or her money for 40 years can probably tolerate more volatility and weather the ups and downs. That investor has time to wait out a decrease in the value of his or her investments before the market bounces back.
In the investing world, the length of time between now and when you’d need your money is known as your time horizon. You should think carefully about this when building your investment portfolio.
Each of us has a different tolerance and capacity for risk based on our goals, personality and life situation. For instance, a single college graduate can probably invest aggressively because time is on his or her side. Meanwhile, a 75-year-old retiree who is saving for the education of a couple grandchildren may not be able to risk a portfolio drop and should thus have a far more conservative portfolio.
How to Build an Investment Portfolio Using ETFs
As mentioned above, an asset allocation is how you distribute the money in your portfolio across different asset classes. The best asset allocation for your portfolio will depend on many factors. If you are just getting started, you should choose a financial advisor to help you understand how different investments could affect you.
As you think about your asset allocation, keep in mind that asset classes are broken down into smaller categories. And each responds differently to market conditions. For example, stocks vary hugely from company to company. That’s why people group similar investments together. This is especially common with ETFs.
An ETF is a fund that includes a number of similar stocks. That could mean stocks from a certain sector of the economy or even stocks from different countries. An ETF could invest only in large, established companies or only in small companies with high growth potential. Investing in multiple types of ETFs will diversify your overall stock investment because you’ll be putting money into funds that behave differently in certain economic conditions. Most robo-advisors actually invest their clients’ money in ETFs.
So as you think about your investments, financial advisors recommend that you create a diverse investment portfolio. That means investing in multiple asset classes. It also means choosing diverse options within an individual asset class.
Bottom Line
When you’re building your investment portfolio, think carefully about your asset allocation. Make sure it adheres to your risk tolerance. This is how well you can handle the ups and downs of the market. Some asset classes, such as stocks, are generally considered more volatile. Meanwhile, fixed-income securities like bonds and CDs are generally considered safer investments. Also, think about your time horizon or the time you have to invest before you’d actually need that money.
Investing and Retirement Planning Tips
- Financial advisors often specialize in investing and planning for retirement. Finding a financial advisor doesn’t have to be hard. SmartAsset’s free tool matches you with up to three vetted financial advisors who serve your area, and you can have a free introductory call with your advisor matches to decide which one you feel is right for you. If you’re ready to find an advisor who can help you achieve your financial goals, get started now.
- A great way to plan for retirement is to calculate how much you’ll need after you retire. Think about the things you’d like to do after your retirement. Do you want to travel? Also, think about where you want to live and what kind of lifestyle you want. For example, you’ll need to save more if you want to retire in a place with a high cost of living. SmartAsset’s retirement calculator can tell you how much you should save each month in order to reach your goals.
- A 401(k) is very useful for building retirement savings. Small, regular contributions can easily add up to plenty of savings later in life. You should especially contribute to a 401(k) if your employer offers a match. If your employer doesn’t offer a 401(k), you can always invest in an individual retirement account (IRA). These work similarly to 401(k)s in that you don’t pay taxes initially on your contributions.
Photo credit: ©iStock.com/utah778, ©iStock.com/ChristianChan, ©iStock.com/asiseeit