Investors talk about about portfolios all the time—they are a basic concept in the world of investing, but for those who are brand new investors it is important that everyone is on the same page.
What is an investment portfolio?
Simply put, a portfolio is a grouping of financial assets.
An investment portfolio could include any of the following:
• Mutual funds
• Exchange-traded funds (ETFS)
• Closed funds
But that’s not all.
A portfolio is an investor’s entire grouping of financial assets.
So in addition to publicly tradable securities like those listed above, a portfolio could include private assets such as real estate, art, or other private investments.
As you can see, a wide variety of assets can be grouped together in a portfolio, but stocks, bonds, and cash are generally considered to be a portfolio’s basic building blocks.
Portfolios are Pizza
Not really of course, but slices of pizza or a pie can be a helpful metaphor.
Let’s say an entire pizza is your portfolio.
Each investment or financial asset is a slice of that pizza. Different slices may be different sizes, but together they add up to be a whole pizza.
The size and composition of each slice is governed by rules that the investor sets based on his or her objectives and tolerance for risk. In the same way that my ideal pizza might not have the same toppings as yours, portfolios are different based on the preferences and goals of individual investors.
What makes one portfolio different from another?
We know that portfolios are made up of financial assets, mainly stocks, bonds, and cash.
We also know that portfolios are different based on individual investor characteristics. So which characteristics or objectives shape investor portfolios?
The investor’s age or the amount of time they anticipate being in the market. This is usually directly tied to financial goals, such as purchasing a house or saving for a child’s college education.
Access to Capital
How much money the investor has and how much they can afford to invest.
Tolerance for Risk
Have you spent decades building a nest egg? It may not be wise to expose your hard-earned safety cushion to risk. On the other hand, if you have disposable income or a short time horizon, the risk may be worth the potential reward.
General Portfolio Management Tips
Don’t put all your eggs in one basket. Practice sound diversification strategies and ensure that you are not overly exposed to a single market sector or asset class.
Don’t ignore costs. Costs such as management fees, fund expense ratios, interest, and other charges add up and eat into your returns. Always look for ways to keep your costs to a minimum.
Don’t ignore tax implications. As with other costs, a rising tax liability can put a serious dent in returns. Plus, we all know the dangers of failing to pay our taxes…
Don’t lose sight of the goal. Unfortunately, money is an inherently emotional topic. When it comes to investing, responding to emotional stimuli can be detrimental to success.
When you have a plan, stick to it. When making a decision, take a second to ask yourself “Am I doing this because it makes sense, or is it an emotional response?”
Maintain your asset allocation (the sizes of each of your different pizza slices) by periodically rebalancing your portfolio.
Building a portfolio—even if you don’t have a lot of money to invest—is an essential first step into the world of investing.
Like many other aspects of investing it is not as difficult as it sounds, but it is important to get it right. The combined factors of time horizon, financial goals, and tolerance for risk shape the ways in which each investor’s personal portfolio develops.