Investment Portfolio Basics: What is it, and How to Build One?

This was originally posted on Planner Bee.

Getting started with investing can be intimidating. So many asset classes, so many options, and so many consequences — talk about analysis paralysis!

The truth is, you don’t have to be an expert finance guru to see rewards from personal investing. In the end, it all boils down to your investment portfolio which you do have to know well.

This article will leave you with a clearer understanding of what an investment portfolio is and how to best put one together.

What exactly is an investment portfolio?

In personal finance terms, an investment portfolio is simply a collection of your financial investments. Think of it as a menu of sorts.

The types of financial investments include stocks, bonds, commodities, cash, and cash equivalents, real estate, art, and alternative investments. You can either manage your investment portfolio yourself, have a money manager handle it, or even get your trusted financial advisor to manage it.

What goes into an investment portfolio?

What your investment portfolio consists of will depend on what assets you’re choosing to invest in. Different assets have different levels of risks and returns, and understanding the pros and cons of each will help better align them with your investment goals.

We will be focusing on the four main types of asset classes today: fixed income, equities, cash and cash equivalents, and others like tangible assets.

Read more: Investment Asset Classes Explained

Fixed income

What is it: Corporate bonds, retail bonds

Risk and returns: Low risk, low returns

Focusing on capital and income preservation, fixed-income securities typically include government, corporate, and retail bonds, and money market funds. Generally, investments under this category hold lower risks but yield lesser returns. They are usually less sensitive to macroeconomic risks such as economic downturns. These investments offer a steady source of income which you receive at regular intervals.

However, fixed-income investments still come with a degree of risk, mainly from interest rates and inflation. Bond prices fall when interest rates rise, making the bonds you hold lose value. Moreover, if the inflation rate outpaces the fixed income offered by the bonds, the investor will suffer a loss in purchasing power.

Equities

What is it: Stocks, equity funds, index funds

Risk and returns: High risk, high returns

An equity investment, also known as stocks or shares, represents money invested in a company by purchasing its shares on a stock exchange.

By holding shares of a company, you have partial ownership of the business. You would expect them to perform well financially as your returns are directly dependent on how well the company is doing, either with capital gains and/or generating capital dividends for its investors.

This is also why equities are famously known to be the riskiest asset class due to their volatile nature. Likewise, it’s also the one that has historically produced the highest returns.

Cash and cash equivalents

What is it: Savings accounts, fixed deposits, treasury bills

Risk and returns: Low risk, low returns (more so than bonds)

The cash and cash equivalents asset class is pretty straightforward — actual cash on hand and securities which are similar to cash. If you have funds in a savings account or tucked away in Fixed Deposit (FD) accounts, then this asset class is already part of your portfolio.

It also comprises cash equivalents like treasury bills, short-term bonds, and commercial papers. While fixed-income investments are focused on long-term growth, investments in cash and cash equivalents are usually pursued for their liquidity as they have shorter maturities.

Read more:__ All You Need To Know About Treasury Bills

Tangible assets

What is it: Property, commodities like gold and fossil fuel

Risk and returns: Variable

Tangible assets have a finite monetary value and are usually in a physical form. A few examples of tangible assets include investments in real estate and commodities. Property investment could mean anything from rental income and REITs to property appreciation, but it certainly doesn’t come easy given its high barrier to entry.

While commodities like gold and crude oil are not typically sought after by personal investors, they may make up a small percentage of a larger portfolio as a tool for diversifying.

Building the right portfolio for you

The different types of assets above make up your platter of potential ingredients. Now, how you choose to mix and match those ingredients could result in a deliciously rewarding plate.

Structuring your asset allocation will depend on a multitude of factors. Things to consider when allocating your assets:

• Your investment end goals
• Your initial capital available
• Your level of risk tolerance
• Your investment horizon

As time passes and based on how the different asset categories perform, your initial allocation could differ as well. This is when you come back in to rebalance your portfolio.

What are your investment end goals?

A 21-year-old student, a 30-year-old young adult, and a 45-year-old family breadwinner have vastly different investment end goals. You could be saving up for a rainy-day fund, prepping for a new life milestone, or building up your pot of gold for a comfortable retirement.

If your end goal is capital appreciation, which is a rise in an investment’s market price, your portfolio will prioritize long-term growth — we’re talking upwards of ten years. The lion’s share of such a portfolio would consist mostly of stocks, and if possible, real estate investments.

Older investors, however, are usually more concerned with capital preservation as they have more liabilities. A conservative strategy to prevent loss by investing in safer assets such as Treasury bills and certificates of deposit will be more suitable for these people.

How much to invest?

You’ve probably heard this before: never invest money you can’t afford to lose. It’s a simple but important rule.

Before you dive in, make sure your emergency fund is well-stocked and you’ve paid off your high-interest debts. You should be looking at three to six months of emergency fund savings before dipping your toes into investing.

Thereafter, work out the comfortable amount you can afford. This can only be done after looking at your monthly expenses and taking into account a fixed amount of savings that remain liquid for other uses.

What is your risk appetite?

Most investment portfolios are categorized by risk, which is the main determining factor for what assets actually go into the portfolio.

Your risk tolerance can be broadly categorized into

• Aggressive
• Moderately aggressive
• Moderate
• Moderately conservative
• Conservative

An aggressive portfolio means you’re willing to put your funds on the line for the possibility of greater gains (keyword: possibility).

This type of portfolio is typically an equities-focused portfolio where investors seek out unique businesses in the early stages of growth or buy into initial public offerings (IPOs). By taking chances at riskier or newer businesses, the potential for better returns (and higher losses!) is much more than investing in well-established companies.

With a lower percentage of stocks in its asset allocation, moderately aggressive portfolios average 60% – 65% of equities and fill the rest with fixed-income securities. It focuses on capital growth and still carries a substantial amount of risks.

Aggressive and moderately aggressive investment strategies are generally believed to be suitable for young adults as they will have a longer investment horizon. This allows them to ride out market fluctuations or even investment losses early in life and still have the possibility to recoup the losses.

A moderate portfolio is also known as a balanced portfolio where the asset composition is almost equally divided between equities and fixed-income securities.

On the other end of the spectrum, moderately conservative and conservative portfolios prioritize capital preservation. This means you don’t mind your portfolio realizing smaller gains as long as some steady returns are guaranteed. These portfolios generally allocate a larger portion of the total to lower-risk investments such as fixed-income and money market securities.

Even for the most conservative investors, having a small portion of your portfolio invested in stocks is recommended to help offset inflation. These people can consider investing in high-quality blue-chip companies or index funds.

Your investment horizon

Your investment horizon is the length of time that you plan to hold onto the investment. It can span from a few days to decades-long. Typically, a horizon of ten years and above is considered long-term, while three years and below is considered short-term.

Naturally, a longer time horizon is associated with lower volatility and gives time for your investments to grow, making it suitable for a more aggressive portfolio. If you’re investing for a long-term goal such as retirement, you can afford to make riskier decisions (within reason of course!).

Diversifying your investment portfolio

Diversification means spreading up your investment into various asset classes, such as stocks, bonds, fixed deposits, and property, to limit exposure to a single type. Diversification can also mean investing in different countries, industries, and with a variety of maturity term lengths.

Diversifying is the golden rule to cutting down on your portfolio’s risk. With a well-diversified portfolio, each of your investments operates in different environments and is inherently different from the others. Losses in one area will, hopefully, be offset by gains in another.

For young enthusiastic investors with ample funds, you might be tempted to opt for stocks entirely. After all, high risk high reward, right? Putting all your eggs into one basket, however, only means that you stand to lose everything.

Below is a general example of a well-diversified investment portfolio for high-risk investors:

*This sample is for educational purposes only and is not meant to be used as a direct reference.

In conclusion…

Learning about how to build your investment portfolio can be a daunting and confusing matter. There are many things to consider — investment amount, end goals, risk appetite, and timeframe to name a few. However, the earlier you learn about these, the more time you will have to invest.

Did you know you can use the Planner Bee app to view your own investment portfolio? Discover how you can automatically link and manually input your investments, or find out more about Planner Bee here.