How To Start Building Your Investment Portfolio

Portfolios to you may mean those massive files art students lug around, but when you’re talking about investing, an investment portfolio means a whole different thing altogether.

While it may seem like a treacherous path ahead, there is nothing complicated and complex to worry about. Managing a portfolio of investments reaps many rewards and can help you earn better returns that you can direct into your future.

What is an Investment Portfolio?

A portfolio refers to the combined management of your investments. Instead of investing in one asset at a time, portfolio investing is about choosing which assets to buy and sell and in what proportion on a holistic, collective basis. By maintaining a different balance of assets in your portfolio, you are more likely to benefit from higher returns and lower risk to your money overall.

This is due to the benefits of diversification. By having your money placed in a range of different assets – such as cash, stocks, bonds, foreign currency and commodities – you reduce the risk of losing all of your money in one go if the financial market takes a sudden and particular downturn.

What should a portfolio consist of? Investments? Allocations?

The best way to set up your investment portfolio is to accurately assess your current financial situation and your future financial needs. The way to determine which investments are best for you and in what allocation is to identify your investment goals.

If you are saving for your retirement, you have a long-term time horizon to invest your money. If on the other hand, your goal is to support or start a family in the next few years, your time horizon and investment needs are different.

Factors to also consider are the amount of money you have and will need in the years ahead (known as your liquidity needs). On top of your investment goals, you will need to consider your risk tolerance and personality.

Conservative investors prefer to have their money in a lower risk portfolio of investments, whereas some investors who can stomach the volatility of a higher risk mix of holdings may opt to do so in pursuit of potentially higher returns over a shorter timeframe.

Typically younger investors can take on more risk than say an investor nearing retirement – who may need the invested funds as part of retirement spending needs. Younger investors have more time to earn money and rebuild their portfolio if any losses are incurred before they retire. Conservative investing is all about protecting the value of your portfolio. In general, this type of portfolio will include more fixed-income products such as bonds – yet still with a mix of other assets such as equities and cash.

Remember that you need some risk in your portfolio to generate a return. An aggressive investor, however, will be willing to take on more risk in their portfolio and will, in turn, be seeking higher returns in exchange for this. The allocation for this type of investor will include a majority of equity investments – again within a mix of investments to protect some value in the case of a sharp market downturn.

3 bucket rule

The best starting place when setting up an investment portfolio is to remember and apply the 3 bucket rule. Set up your portfolio of investments based on three primary needs:

1. short-term cash needs
2. retirement needs and
3. exploratory investing

Bucket 1 involves holding cash in your portfolio in sizeable enough to cover three to six months of your expenses. By having this buffer, you are protected from having to sell your other investments to raise cash for any day to day need that may arise – such as a hospital visit.

Bucket 2 should be the largest component of your portfolio as it focused on the long-term need for meeting your retirement needs. This part is often called the “core” portfolio.

Bucket 3 is a small amount of capital that you can use to invest in assets that you have researched and believe will perform well, but may come with higher risks. You may lose the money in this bucket, but it is set aside intentionally to explore investment ideas while maintaining your cash buffer and retirement investing in Buckets 1 and 2.

Remember when setting up your portfolio to keep a close eye on costs. Minimising costs can add up to better returns on your money over time as these savings accumulate and grow.  One great cost effective option is to invest in index funds or index Exchange-Traded Funds (ETFs) rather than actively managed mutual funds – which can sometimes involve high management costs.

How to build a portfolio

Once you have identified your investment goals and allocations, you can set to work building your portfolio. The thing to remember is to properly research the merits and risks of each asset you are looking to add to your portfolio.

Stock picking and bond picking involves choosing stocks and bonds that meet your risk needs. Mutual funds are also available and offer investment in a broad range of asset classes that are professionally researched and picked by fund managers. ETFs provide a good alternative if you prefer not to invest in mutual funds. ETFs are similar to mutual funds in that they cover a basket of stocks – usually grouped by a style sector, capitalisation or country.

The difference is that ETFs are not actively managed, instead of tracking a chosen index or basket of stocks. This passive management means ETFs offer cost savings over mutual funds while providing diversification. ETFs also cover a range of asset classes and can be useful for providing diversification to your portfolio.

Don’t be afraid of building one

It might seem complicated when you first start setting up your portfolio, but once you get going, you will find that portfolio investing is not as complex as you initially thought. The best way to be successful in portfolio investing is to jump in and begin.