What to Consider When Building an Investment Portfolio

TL;DR

• Investing may be a good way to build wealth over the long term, but it can be daunting to figure out where to start as a beginner. 

• Building a personal investment portfolio is an important step toward achieving financial goals, and it requires careful planning and consideration of several factors, including the nature of these goals and risk tolerance. 

• Regular monitoring and adjusting a portfolio is necessary to maintain an investor's desired asset allocation.

What Is an Investment Portfolio?

An individual's investment portfolio is the collection of assets they own, including stocks, bonds, and cryptocurrencies.

Investing can be a great way to build wealth over the long term, but figuring out where to start can be overwhelming. This is especially true when newer investment options like cryptocurrencies are thrown into the mix. 

Building a personal investment portfolio is a crucial step toward achieving financial goals, and it requires careful planning and consideration of a few factors. Let's take a closer look at a few key considerations involved in building a personal investment portfolio.

Evaluating Risk Tolerance in Portfolio Planning

Risk tolerance refers to an investor's willingness and ability to withstand losses. For beginners, this means taking into account considerations such as their end goals, their current financial situation, and their understanding of investment products, among other factors.

Defining goals

The first step an investor could take to determine their risk tolerance is to define their financial goals. For example, common long-term investment goals may include saving for retirement or building wealth for future generations, while short-term goals may include purchasing a car or pursuing higher education in the near future.

These goals may have knock-on effects on risk management and tolerance because financial goals could dictate an investor's time horizon, which is the length of time they plan to hold their assets before cashing in on them. 

The longer the time horizon, the bigger the risk an investor may take, as long-term gains may counterbalance short-term price dips. Entering the market with shorter time horizons, such as planning to buy a house in two years, means losing a portion of the capital to short-term price fluctuations could set this goal back significantly.

Current financial situation and obligations

Being fully aware of current financial obligations can help determine how much money investors may invest without compromising their ability to pay bills, debts, and other necessary expenses.

For instance, an individual with a stable income and an emergency fund that could cover medical expenses, a job loss, or home repairs may be more willing to take on riskier investments, such as cryptocurrencies. The recommended emergency fund is generally enough to cover an individual's financial obligations for the estimated time it might take them to find a new job in their industry and specialization.

On the other hand, someone who has yet to save up for emergencies might need to consider a cash-heavy investment mix so that an unexpected setback won't result in having to liquidate high-risk assets, potentially incurring a loss.

Understanding different asset classes while investing

Another factor investors might need to consider when making decisions on risk tolerance is their knowledge and experience with the assets they plan to add to their portfolio, especially if this involves cryptocurrencies. For example, if they have a good understanding of the crypto market and how crypto wallets work, they may feel more comfortable taking on the risks associated with this investment. 

However, investors who are new to crypto may want to start with a smaller capital and increase their holdings as they get more comfortable with the market and the volatility that comes with it.

Strategizing Asset Allocation for a Balanced Investment Portfolio

Asset allocation is the process of dividing investments into different asset classes, such as stocks, bonds, cash, and alternative investments like cryptocurrencies. Striking the right balance could give investors a leg up in achieving their goals. 

Generally, a conservative investor may choose to have a higher percentage of bonds and cash in their portfolio, while an investor with a longer time horizon might choose to have a higher portion of individual stocks and crypto assets. It's important to note that asset allocation is not a one-time decision and may need to be adjusted over time as investment goals and risk tolerance change.

For instance, an investor with a large cash reserve may allocate 70% of their capital to stocks, 20% to bonds, and 10% to cash. Choosing to allocate 70% of their portfolio to stocks might be deemed risky. Still, if this investor is able to cover unexpected expenses with their 10% cash reserve, they might feel comfortable taking this risk.

Alternatively, someone close to retirement might choose to hold more bonds and cash while allocating a small portion of their holdings to stocks and crypto. If their cash can cover their expenses in retirement, they could hold a small portion of their funds in riskier assets.

How to Diversify Your Investment Portfolio

A diversified portfolio can allow investors to weather price dips in individual stocks and cryptocurrencies. Investors may choose to minimize the risk of loss due to the concentration of investments in one geographic area or sector by spreading investments across different asset classes, sectors, and regions.

Investors could diversify by investing in mutual funds or exchange-traded funds (ETFs). But note that diversification does not guarantee a profit or protect against loss in a declining market. While it's a good strategy, it's not risk-free.

Mutual funds and ETFs may be more suitable for investors who prefer a hands-off approach to diversifying, as accredited financial institutions choose the bundle of stocks and shares included in these funds. The S&P 500 and the FTSE 100 are prime examples of funds that offer a hands-off approach. Investors could allocate a portion of their salaries to purchasing these products each month.

If an investor prefers diversifying by picking their own investments, There are a variety of investment products available, including individual stocks, bonds, and crypto. It's essential to conduct thorough research and understand each investment's risk and potential return. Tools such as Morningstar, Bloomberg, and CoinMarketCap are good starting points.

How to Monitor and Rebalance Your Investment Portfolio

Building a personal investment portfolio is not a one-time event. It might be an ongoing process that requires regular monitoring and adjustment. Investors may need to rebalance their portfolios periodically to maintain their desired asset allocation. 

Investors may also need to adjust their portfolios if their investment goals or risk tolerance change. Let's say an investor has a diversified portfolio that comprises 60% stocks, 30% bonds, and 10% cash. After finding themselves in a better financial situation, they may now have a higher risk tolerance and be willing to take on additional risk in their investments in pursuit of greater returns. Assuming the investor has done their research, they might adjust their portfolio to hold less cash and more bitcoin. By increasing their bitcoin holdings, they are increasing their potential for higher returns, taking on more risk in doing so.

On the other hand, rebalancing a portfolio could involve letting go of riskier assets in favor of more conservative options. For instance, an investor approaching retirement might let go of some of their riskier investments while holding onto bonds and cash.

It's important to note that adjusting a portfolio based on risk tolerance is a personal decision that should be carefully considered and aligned with financial goals and investment strategy. It's also important to regularly review and rebalance a portfolio as goals draw nearer.

Closing Thoughts

Building a personal investment portfolio is a complex process that requires time, patience, and an honest look at an individual's current and expected financial situation. There's no one-size-fits-all approach to building an investment portfolio. 

While researching the right assets to hold, new investors need to be mindful of their risk tolerance at all times and avoid financial gurus that may tout specific investments or portfolios promising astronomical returns with minimal risk. This process may take time, but new investors could come out of this process more confident in their ability to manage their portfolio.

Disclaimer and Risk Warning: This content is presented to you on an “as is” basis for general information and educational purposes only, without representation or warranty of any kind. It should not be construed as financial, legal or other professional advice, nor is it intended to recommend the purchase of any specific product or service. You should seek your own advice from appropriate professional advisors. Where the article is contributed by a third party contributor, please note that those views expressed belong to the third party contributor, and do not necessarily reflect those of Hibt Academy.