What is an investment portfolio and how to create one

2024 Author: Malcolm Clapton | [email protected]. Last modified: 2023-12-17 03:44

A comprehensive approach can help you earn more.

What is an investment portfolio

These are all assets in which a person has invested. Usually we are talking about stocks, bonds, exchange traded funds and cash. For example, several Gazprom shares and a small amount of cash can be considered an investment portfolio.

But this concept includes shares in business, real estate, collectible sneakers, and bank deposits. Therefore, there are real investment monsters. For example, the world's largest management company BlackRock owns stakes in 5,454 companies, with the top five accounting for only 13.27%.

Both examples are rather extreme. A Russian investor's portfolio usually includes five asset classes: domestic and foreign stocks and bonds, as well as ETFs.

This approach with the distribution of investments by different instruments, sectors of the economy and countries is called diversification. In a simple way, you don't need to put all your eggs in one basket, it is better to keep many eggs and many baskets. But the exact composition depends on the portfolio choice.

What investment portfolios are

There is no single correct option. Some people need a balance, others are willing to take risks for the sake of potential profit, while others are important to preserve capital. The choice of assets always depends on the investment strategy. But there are templates that you can take as a basis.

Conservative portfolio

It includes shares of companies whose products are always consumed, whatever the state of the economy. These are retailers, developers and manufacturers of food, household goods, building materials and body care products.

The point is that these firms perform equally well in bad times and good times. In a crisis, such companies benefit, so the portfolio is also called defensive. But enterprises do not earn much and in a growing market they lose to more promising sectors of the economy. Investors also lose in profitability: since firms receive less, then there is less free money left for dividends and shares do not add to the price as much.

A conservative approach is chosen by those who do not tolerate volatility and high risk in investments, therefore, in return, they are ready to sacrifice potential profitability. If the goal is to preserve capital for many years and slightly increase it, then this is a good option.

Passive portfolio

The bottom line is to bring the investor the income that a person lives on. To do this, dividend stocks and constant coupon bonds are added to the portfolio.

"Passive" investors are not looking for a way to multiply their capital, they just need regular payments from large and stable companies. A portfolio is similar to a conservative one, but is better suited for a shorter time horizon - from a few months to a couple of years.

The fact is that the bonds have a period in which they will be redeemed, and the papers will have to be renewed. And yet not all dividend firms are doing equally well during different economic cycles: on the eve of a crisis or immediately after it, there may not be enough money to pay shareholders.

Hybrid portfolio

The main principle is maximum diversification. This means that the investor tries to distribute money between instruments that react differently to the same events. This way you can protect yourself from volatility and maintain good returns.

Usually, dividend and moderately growing stocks are chosen for this option. As a rule, these are large companies that make up stock exchange indices like the Mosbirzh Index, the S & P 500 or the Nasdaq Composite. And they supplement these securities with reliable bonds that are issued by developed countries or stable large firms.

Screenshot: Canva

Screenshot: Canva

This option is suitable for those who do not like to take risks once again and are ready to invest for a period of 3 to 5 years. The profitability is averaged over the years and does not affect the investor's money as much as with short-term investments. And the correlation between asset classes is also low - the price of one rarely depends on the value of the other. That is, such assets react to different events in different ways, so the entire portfolio is unlikely to fall sharply in price due to some unfortunate news.

Aggressive portfolio

Another name is the growth portfolio, because it is chosen by investors looking for promising companies. Such people are ready to take a high risk of financial losses for the chance to earn a lot.

With these options, you have to spend a lot of time and money. You need to find a young, poor and fast-growing company, and then invest in it directly. These are the spheres of "angel" and venture investments, when firms are not yet public. Investments are usually in the hundreds of thousands and millions of dollars. For people without such start-up capital, IPO funds or collective investments, for example, are available. In these cases, a group of persons invests in a non-public business, and then divides the profit among themselves.

High-risk assets are also included in this category. For example, developing a breakthrough cancer drug can take several years and cost millions of dollars. But the result may not be at all, and government regulators do not always certify drugs. Then the firm will most likely close and investors will lose money.

Growth investors often have a long time horizon. They can wait for years while the company develops, takes over new markets and prepares to go public.

This is risky because the product may fail, the business model may be wrong, and the management may not be up to the job.

Speculative portfolio

No less dangerous than aggressive. The main difference is that the portfolio combines investment and trading. One part is reserved for risky investments, and the other - for playing on short-term price fluctuations. But it is difficult, requires experience and special knowledge, so it is better to leave this to professionals.

For example, in the fall of 2020, Yandex technology company and Tinkoff bank announced a merger. Because of this news, the prices of shares of both firms jumped, that is, investors rushed to buy assets. But after a month and a half, the plans for the merger fell through, and an experienced trader could well have predicted this: analysts warned about different corporate cultures, a dubious assessment of the transaction and difficult negotiations. Knowing this, the specialist could bet on the fall in shares and make money on the failure of the agreement.

How to form an investment portfolio

If you pounce on a stock market with thousands of assets and the goal of buying something, it is unlikely that the venture will turn out to be profitable. Even if everything goes well, it will be a gamble, not a work on wealth. So at the very beginning it is better to tackle four questions.

1. Choose a way to manage your portfolio

Some investors can make investments the old-fashioned way: pick up assets, read multi-page reports, and calculate multiples. This will allow you to build a perfectly fitting and balanced portfolio. However, this method is almost a full-fledged job, for which not everyone has the time, energy and desire.

The second way is to find an assistant. Sometimes this is a financial advisor who will ask about all the introductory and offer assets, but will take a fee or commission for this, which will affect the overall return. And sometimes - a roboadvisor, an automated assistant, which almost every broker has started on a website or in a mobile application. Such an assistant will remove some of the worries from the investor, but the portfolio will be quite standard, and not the fact that it is ideal.

The third group of those wishing to invest does not need this either. Their option is to invest in exchange-traded funds. People who are not ready to pick up every asset invest in tens and hundreds of securities, which are managed by professionals, with one purchase. But in this case, you will also have to come to terms with losses - the fund's management commission.

2. Determine the time horizon

The choice of portfolio type and assets is highly time-dependent. If money is needed in a couple of years, then risky investments on such a horizon can nullify capital due to high volatility. And if there are 15, 30 or 50 years in stock, then the same investments can multiply several times, in some cases - tens and hundreds of times.

But usually financial advisors recommend balancing risks and mitigating them over time.

For example, a 20-year-old investor builds a portfolio for retirement. In the first years, a person invests in fast-growing and risky assets: on some he loses money, on others he earns, and the value of the portfolio is constantly jumping.

But it doesn't matter until retirement comes. Then it is worth gradually selling risky assets and replacing them with dividend stocks of stable companies and bonds and living on the income from these securities.

3. Understand risk tolerance

The choice of assets also depends on it: some are more risky than others, but also more profitable. The balance here is determined by the investment strategy.

Let's say risky futures or cryptocurrencies can crash by 40-50% in a few hours. If the thought becomes very disturbing and unpleasant, then it is worth considering a larger share of bonds or index funds.

4. Focus on diversification

This is the foundation on which the whole theory of investment portfolios stands. Without diversification, there is no point in doing everything else.

But it’s worth tackling it at the very end, when you understand your goals and characteristics as an investor. Only then does it make sense to determine the asset classes, and then disperse them across sectors of the economy, countries and currencies.

What is worth remembering

1. Investment portfolio - all assets of an investor, from stocks and bank deposits to an apartment and a share in a business.
2. The point of a portfolio is to strike a balance between risk and return.
3. The selection of assets depends on the investment strategy.
4. Before building a portfolio, it's worth understanding your personal risk tolerance, investment horizon, and asset management.
5. For private investors, the hybrid option is most likely suitable - not the most profitable, but not very risky.