Last week, we talked about the different types of investment portfolio based on the investor’s expected outcome and risk tolerance. This article aims at giving practical steps on how to build the portfolio. Let us dive right into it.
‘Do not put all your eggs in one basket’ is a common idiom used to advise people to avoid putting all their hope in one thing. This also applies to investments. According to the Corporate Finance Institute, an investment portfolio is a set of financial assets owned by an investor. These assets could include bonds, shares, treasury bills and other securities. An investment portfolio is used by investors to diversify their holdings thereby, ensuring that their eggs are not all in one basket.
When building an investment portfolio, the first step is to determine your objective. Most of us heard about the dip in cryptocurrencies last week. Some investors forget that it is a long-term investment not short-term. When dealing with long-term investments such as cryptocurrencies, stock trading and others, there will be growth and dips over the years. However, there will still be an overall long-term growth high enough to beat inflation and yield real profits, but investors need to be patient and hold on to their investments rather than rushing into panic buying and selling. If your objective is to earn returns within a short period of time, go into short-term investments. Determine your expected earnings’ expectation and match it to the expected maturity date of your choice of assets. In addition to this, you must also consider your risk preference or appetite. Risk appetite is the level of risk an investor can tolerate (Manoukian, 2016). Some investors prefer high risk assets that guarantee high returns within a specific time frame. However, there is also the risk of losing the amount invested to adverse changes in the business environment. Every investor has a risk appetite that guides the way they make their investment choices.
The next step is to allocate your capital to these assets. A useful tip is to avoid investing too much in one class of asset. The reason is that the higher the capital you invest in a particular asset, the higher your break-even point is. For instance, if I invest 100 dollars in shares that pay a constant dividend of 10 dollars per year, ceteris paribus, it will take 10 years for me to get back the full value of my investment. If I invest 150 dollars, ceteris paribus, it will take 15 years to get back my initial investment back before I make any profit on my investment. However, also avoid over-diversification. Your investment portfolio should be large enough to minimize risks yet small enough to ensure you have enough capital in the best opportunities.
There are factors to consider when choosing investments from specific asset classes. If an investor is to buy shares in a company, they would need to consider the economic sector the company operates in, the market capitalization of the company, the dividend history, earnings per share, other investors’ ratios and so on. When investing in company stocks, have stocks in multiple companies across the various markets for risk minimization.
When buying bonds, an investor needs to consider the coupon rate, maturity date and the credit rating of the bond to ensure these meet their objective.
In step three, you invest in your selected assets. There are several online platforms that can be used to invest in securities such as Bamboo, Passfolio, PiggyVest, Rise Vest, Agropartnership, Bloomberg Buy-Side Solutions, etc. Please note that we are by no means advocating for any of these platforms. Always conduct due diligence and investigations before using these or any other investment platforms.
The final step is to periodically reassess the performance of your portfolio. This entails analyzing the performance and risk profile of each of your investments then, making any necessary adjustments. This ensures your ‘mix and match’ investment portfolio is running at an optimal level and is in alignment with your overall objectives. Always remember that the role of consistent research and monitoring of the investment markets can never be overemphasized.
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Corporate Finance Institute. (2019, March 27). Investment Portfolio. https://corporatefinanceinstitute.com/resources/knowledge/trading-investing/investment-portfolio/
Gallant, C. (2020, February 19). Learn 4 Steps to Building a Profitable Portfolio. Investopedia. https://www.investopedia.com/financial-advisor/steps-building-profitable-portfolio/ Manoukian, J. (2016, September 29). Risk Appetite and Risk Tolerance: What’s the Difference? Enablon®. https://enablon.com/blog/risk-appetite-and-risk-tolerance-whats-the-difference/