Since the start of the Pandemic, the stock market has increased to levels never before seen. Many individuals may be interested in starting their own investment portfolio and it is one of the most important financial steps an individual takes. Creating an investment portfolio can seem like a daunting task, but the process to create a thriving portfolio will be laid out step by step, allowing you to take advantage of the record-breaking stock market in no time. Read more to build your investment portfolio.
An investment portfolio is just the collection of all of the investments an individual has made and currently holds, all of which are assets. This ranges from stocks, cash, bonds, real estate, ETFs, and in today’s world, cryptocurrencies. An investment portfolio helps individuals with gauging how good all of their investments are as a whole and not based on separate investments for example.
With all investments, it is important to note that the higher the risks involved, the higher the returns, and the lower the risks, the lower the returns. One of the first things to do before starting to build a portfolio is to determine the level of risk you are willing to take on. Traditionally, the younger the investor, the more risk they take on and gradually decrease the level of risk over the decades as they age. Despite tradition dictating risk levels, there is nothing wrong with taking on investments with lower risk when you are younger. In this guide, we will be following the traditional method of asset allocation but what are some factors that determine risk?
Investment risk can encompass various industries, company sizes, and countries. Some industries such as energy can be riskier to invest in due to the price of oil increasing or decreasing on short notice called volatility. Some countries experience economic downturns or political instability leading to loss of investment. Bigger companies that have been established in their respective industries for decades are typically safer investments than companies that are new to an industry with examples of established companies being Apple, Visa, and Johnson & Johnson.
With today’s technology, opening a brokerage account has never been easier with many different brokerages that fit your needs. Once completed, you will need to determine your asset allocation. Simply put, asset allocation refers to the percentage of each type of asset that is contained in your overall portfolio, and to determine what percentage is allocated to what assets, an individual would need to take into account their age and future income. To get an understanding of how much to allocate, we can use the rule of 110, where an individual subtracts their age from 110, and based on the result, they would allocate it into stocks.
For example, if an individual is 32, we subtract 32 from 110, giving us 78. This would mean 78% of your portfolio should be in stocks while the remaining 32% should be in bonds. The rule of 110 is, of course, not set in stone and can be altered depending on an individual’s risk levels. For example, a person can put more into bonds if they do not like to be exposed to higher levels of risk.
One of the hardest aspects of building a portfolio from scratch is individually picking the stocks that will be part of the portfolio. The stocks that are chosen will need to align with your risk level, as there are many different types of sectors, stock types, and market caps to choose from. Sorting through thousands of stocks can take an incredibly long time and it is advisable to use stock screeners, which is a tool that allows investors to sort through all of the available stocks on the market based on their criteria.
To help expedite the stock selecting process, a part of the investment portfolio can also be mutual funds, which are financial vehicles that are made from a pool of investor capital, which then is invested on behalf of the investors. They can represent various stock sectors, bonds, real estate, or commodities. Mutual funds are operated by professional financial managers who can research each stock that is included in the fund.
This ensures that the stocks which comprise the fund meet the fund’s requirements, objectives, and mission. Choosing to invest in a mutual fund can take much less time than handpicking every stock in one’s portfolio, but mutual funds do come at a slight cost. Each mutual fund has its expenses that pay for the management team which can range from 0.3% to 2%, with the average mutual fund costing being about 1.4%.
There is also an alternative to mutual funds that can better suit the needs of an individual that is looking to start their portfolio, which is Exchange Traded Funds, or ETFs. An ETF can be considered to be a basket of financial securities such as stocks, commodities, or bonds in which investors of all sizes can trade on any platform. The ETFs can represent almost every financial security there is.
ETFs have come to replace mutual funds in recent years due to their overwhelming benefits for investors, especially investors that are beginners and individuals who are looking to start their portfolios. ETFs offer investors a much broader range of benefits, from mirroring indexes such as the Standard & Poor’s 500 (SP& 500), Dow Jones Industrial Average (DOW), gold, iron, and every available sector. ETFs are also similarly loosely managed by a professional financial team, but their rates are typically much lower, averaging about 0.3%.
There are key differences between ETFs and mutual funds, both of which are some of the most popular traded securities among investors. Unlike ETFs, mutual funds allow investors to purchase fractions of shares, such as 1.4 shares of a particular mutual fund, whereas ETFs do not allow fractional shares. Another important aspect that differentiates mutual funds and ETFs is that mutual funds reinvest their dividend earnings back into the fund, whereas ETFs will simply send the dividend amount to the investor.
There are other aspects that make ETFs more popular than mutual funds. One of which is once an order for any mutual fund is placed in the market, the mutual fund shares are purchased at the end of the day regardless of when the order was placed. Investors can purchase ETFs at any time during the day, just like any other stock being traded. Although there are a few exceptions, ETFs offer their investors much more flexibility and lower expense ratios.
The second part of building a portfolio from scratch after investing in the stock market is the bonds market. Although investing in bonds may not be available on the investment platform you are using, it will still be part of your portfolio even if it is purchased on another platform. But when it comes to bonds, the main aspect is the bond rating. There are three main global rating agencies which are Standard and Poor’s, Fitch Ratings, and Moody’s whose job is solely to inform investors of a bond’s risk levels.
The ratings range from AAA, which are the highest quality bonds. The lowest quality bonds are typically noted with a C or D, meaning the risk of default/bankruptcy is near. The closer the rating is to the AAA rating, the safer the bond is and as a result, the lower the returns and vice versa. The bonds portion of the portfolio should be a mixture of AAA-rated bonds and BBB-rated bonds. If an individual is more risk-tolerant, they can venture into lower-rated bonds for higher returns.
The building of a portfolio can be intimidating, but it doesn’t have to be. With the proper guide, building a portfolio can be quite easy. Financial education is key in building a well-rounded portfolio and there is nothing wrong with consulting with a financial advisor to guide you down the correct path. Building a portfolio is not a one-time action. It requires modifications and alterations throughout the years. The main points when building a portfolio is to keep your objectives in line with your investing, stay within your risk tolerances and understand the investments you will be undertaking.
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