The first step: determine the appropriate asset allocation
Verifying your individual financial position and goals is the first task in creating a portfolio. Important elements to consider are the age and the amount of time you have available to develop your investment, as well as the amount of capital to invest and future income needs. A 22-year-old unmarried college graduate just starting his career needs a different investment strategy than the 55-year-old married person would expect to help pay for a college child's education and retirement in the next decade.
The second factor to consider is your personality and risk tolerance. Are you willing to risk the potential loss of some money for the possibility of greater returns? Everyone wants to reap high returns year after year, but if you can't sleep at night when your investment falls in the short term, chances are the higher returns from these types of assets are not worth the stress.
Clarifying your current situation, future capital needs, and your tolerance for risk will determine how your investments are allocated between the different asset classes. The possibility of achieving greater returns comes at the expense of greater risk of losses (a principle known as the risk / reward swap). You don't want to eliminate risks as much as you want to improve them according to your individual situation and lifestyle. For example, a young person who will not have to depend on his investments for an income can take greater risks in looking for high returns. On the other hand, a person approaching retirement needs to focus on protecting his assets and reaping income from these assets with an efficient tax method.
Conservative versus aggressive investors
In general, the more risk you can take, the stronger your portfolio will be, as you allocate more to stocks and less to bonds and other fixed-income securities. Conversely, the less risk you can take, the more conservative your wallet will be. Here are two examples, one for the conservative investor and the other for the overly aggressive investor.
The primary goal of a conservative portfolio is to protect its value. The allocation explained above will bring current income from bonds and will also provide some long-term capital growth potential from investing in quality stocks.
The second step: completion of the portfolio
Once you have determined the correct asset allocation, you will need to divide your capital between the appropriate asset classes. At the most basic level, this isn't difficult: stocks are stocks and bonds are bonds.
But you can divide the different asset classes into subcategories, which also have different risks and potential returns. For example, an investor may divide the share of shares in a portfolio between different industrial sectors and companies with different market value, and between domestic and foreign stocks. The bond portion may be allocated between short-term and long-term debts, government debt versus corporate debt etc.
There are several methods you can take to choose assets and stocks to fulfill your asset allocation strategy (remember to analyze the quality and potential of each asset you invest in):
Stock picker - choose stocks that meet the level of risk you want to assume in the stocks portion of your portfolio; Sector, market capitalization, and equity type are factors to consider. Analyze companies that use the stock checker to select potential options, and then perform more in-depth analysis of each potential purchase to identify future opportunities and risks. These are the most labor-intensive means of adding securities to your portfolio, and they require you to monitor price changes in your properties regularly and stay up-to-date with company and industry news.
Bond selection - When choosing a bond, there are several factors to consider including coupon, maturity, bond type, and credit rating, as well as the general interest rate environment.
Mutual Funds - Mutual funds are available for a wide range of asset classes and allow you to hold stocks and bonds that are professionally researched and selected by fund managers. Of course, fund managers charge for their services, which reduces your returns. Index funds offer another option; It tends to have lower fees because it reflects a well-established index and is therefore passively managed.