Categories
General

The 7 Things You Need to Know About Building Your Investment Portfolio From Scratch 

Stats like these fly around all the time—and inspire new investors to build investment portfolios from scratch. But, once stock prices begin to fall, these investors panic and sell, fearful of losing their money.

If you had put $400 into one Tesla share in November 2021, your money would have almost tripled by now.” 

As soon as it looks like the market is going green again, the fear of missing out kicks in, and they want to buy in again. Rinse, repeat. The pros call this the Fear–Greed cycle.  

It’s the biggest reason novice investors pull out of the market entirely and probably conclude that investing is not for them. 

But, investing is for everyone. Putting your money to work for you is a wiser way to attain financial independence than just stashing cash in the bank, where fees and inflation will slowly but surely erode its value. 

You see, investing is a marathon, and if you treat it like a sprint, you’ll be heading nowhere fast. With knowledge of a few fundamental principles, you too can become an investor that makes calculated decisions and consistent gains. 

To help you get started, here are seven things to know about building your investment portfolio from scratch.

1. Yourself

Start with defining your investor persona and intent. You can’t take a trip without a destination and a purpose (or at least, you shouldn’t). 

So, before you start building your investment portfolio, you want to have clear answers to some crucial questions:

  • Why am I investing? It’s vital to set investment goals from the outset. They’ll be the guiding principles for deciding how accessible your portfolio will be and what assets you’ll invest in. For example, if you’re investing for retirement, play the long-term game and choose assets that only have long-term potential. 
  • How much am I investing? The best way to stay on track with your investment goals is to set aside a fixed amount for investment per period. How much you invest and how frequently you do it is up to you, but you want to ensure you’re consistently building your portfolio. Some investors can afford to put in a lump sum at once, while others may have to stagger their capital contributions into the investment fund. 
  • What is my risk tolerance? Investing is a game of risk and returns. Seasoned investors are aware of and even anticipate downturns. But, investors don’t all have the same level of patience, perseverance, and frankly, guts. It’s important to know your risk tolerance before you start investing. Is it conservative, moderate, or aggressive? The answer will influence the assets you invest in as well as the investment goals you’re willing to pursue. 
  • How long am I investing? The answer here will depend on your portfolio. Some asset classes will require a short-term outlook while others might require you to invest for the long term. So, adjust your strategy and appetite as you go.   

After answering these questions, you should have a good idea of your investor persona. That’s the first step in defining and building your investing journey. 

Next up, let’s look at the different types of investment portfolios.

2. Investment Portfolio Types

You can group portfolios according to risk tolerance and expected outcome. Now, what are thooooooose?

Investment portfolio types according to risk tolerance 

As we mentioned earlier, risk tolerance has three levels: 

  • Conservative. Conservative investors are the ones who take the least amount of risk. They opt for the safest investment options. These individuals care more about avoiding losses than about gaining profit. And they only invest in asset classes where their money is safe.
  • Moderate. Moderate risk investors are more risk-tolerant. They accept some risk and usually set a maximum loss percentage to bear. Moderate risk investors put money in various asset classes, both risky and safe. Of course, this means they’ll earn less than aggressive investors when the market is doing well, but they don’t lose as much when the market is falling.
  • Aggressive. Investors who take aggressive risks are well-versed in the market and are willing to take huge risks. Such investors are used to seeing large swings in their portfolios. Typically, aggressive investors are wealthy, experienced, and  have diverse portfolios. They favor asset classes like equities (e.g., stocks) with a dynamic price movement. Because they take huge risks, they benefit from higher returns when the market is performing well, and, conversely, they suffer significant losses when the market is underperforming. 

Investment portfolio types according to expected outcomes

You can define investment portfolios according to your investment goals. Your investing ‘Why’ (which we hope you’ve answered by now) will determine what kind of investment portfolio you curate. 

Here are three standard types:

  • Income portfolio. Income portfolios are focused on securing regular income from investments. We discussed conservative investors earlier; income portfolios are their jam. Income portfolios typically comprise low-risk assets (e.g., fixed income, bonds) that guarantee consistent income and capital stability.
  • Growth portfolio. Many financial companies make it a point to add that past performance is not a guarantee of future returns. Growth investors defy that notion and choose to raise high stakes in hopes of high returns. They bet on stocks that have shown above-average growth (in earnings, revenue, or some other metric).
  • Value portfolio. Value investors buy promising stocks when they are undervalued, expecting the price to rise once other investors catch on. The reasons these stocks are undervalued can vary widely, including a short-term event like an internal organizational crisis or a longer-term phenomenon like an economic regression. Like Warren Buffett, value investors are not looking to jump over seven-foot bars; instead, they look around for one-foot bars that they can step over.

3. The available investment options 

Now that we’ve addressed the why and how of investment let’s look at the what

Asset classes differ in risk and rewards. And you should select an asset class based on your personal goals and risk tolerance, not anyone else’s. 

Novice investors tend to be swayed by the fear of missing out and will put money in some assets simply because they’re popular. That’s one way to crash and burn faster than choppers in action movies.

Some standard asset classes include:

  • Cash. Cash investment is a short-term obligation that pays interest, usually less than 90 days. Compared to other investments, cash investments typically provide a low return.
  • Bonds. Bonds are securities in which an investor lends money to a company or government for a set period in exchange for regular interest payments. When the bond matures, the bond issuer returns the money to the investor.
  • Stocks. A stock (also called equity) is a financial instrument representing ownership of a portion of a company. “Shares” are the basic units of stock. Investors buy and sell stocks primarily on stock exchanges, but private sales are also possible.
  • Alternative investments such as crypto. 

4. Asset allocation 

If you’re investing in more than one asset, asset allocation is critical. 

Say you’ve decided that you’ll invest in some stocks, fixed income, and crypto-based on your investment goals and profile. Asset allocation is how you determine what percentage of your capital goes into each asset class.

So what are the criteria for selecting asset classes for your investment portfolio?

When choosing between different investment options, consider if the asset class(es) you’re going for has:

  • A low correlation with the other asset classes in the portfolio. Low correlation means that different asset categories have performed differently.  When the returns on some asset classes fall, the returns on others fall less or even rise. This way, investors can hedge from the market’s crazy swings.
  • Long-term positive expected returns. Preferably much higher than the expected inflation rate.

When choosing what to invest in, remember more isn’t always better. It may be wise to avoid having more investments than you can follow or understand.

5. Diversification

Newbie investors often confuse asset allocation for diversification. 

While asset allocation is how much of each investment class you hold in your portfolio, diversification is the assortment of investment options within each particular asset class. 

Think of an imaginary investor. Call him Bullbear. He holds 30% in stocks, 40% in bonds, 20% in real estate, and 10% in crypto. That’s the asset allocation.

In the Stocks assets class, Bullbear then holds various shares—S&P 500, Apple, Disney, PayPal, Facebook, Berkshire Hathaway, Amazon, Square, you get the gist. That’s diversification.

Just as with asset allocation, the goal of diversification is to hedge against extreme losses and increase chances for more significant growth. So, investors decide how to allocate their investment portfolio between asset classes. And then choose how to diversify within those classes. 

6. Investment turnover

Turnover is the total percentage of your portfolio that you sell in a particular period —usually monthly or yearly. 

Say a portfolio with $10 million in assets under management sells $2 million in securities during the year. That means the turnover rate is $10 million divided by $2 million, or 20%.

As a fledgling investor, you must determine how long you will hold your investment for. While some investors may purchase and sell assets often, this can result in higher transaction costs and lower expected returns. Experienced investors consider investment funds with excessive turnover as low-quality.

7. Portfolio evaluation

Once you’ve built a portfolio, you need to review it regularly as market moves may cause your initial weightings to change. 

Say you’re holding 40% in stocks; surges may cause that percentage to increase to 48%. You can choose to sell some of your stocks or invest in other asset classes until your stock allocation returns to the original 40%.

Other factors in your investment profile will also change over time—your financial condition, future demands, risk tolerance, and short-term goals. 

When these factors change, you may need to change your portfolio. 

For example, if your risk tolerance decreases, you may need to cut the number of stocks you’re holding. If you’re ready to take on more risk, your asset allocation may change to make room for a small percentage of your portfolio to invest in more small-cap stocks.

The Future Won’t Take Care of Itself

Contrary to what YOLO advocates say, the future will not take care of itself. 

You can, and should, look to make decisions that will increase your chances of having a stable financial future. The best time to do that was yesterday, but it’s okay to catch up now. 

“Anyone who is not investing now is missing a tremendous opportunity,” says Carlos Slim, veteran investor, and Mexican telecoms magnate. We couldn’t have said it better (actually, we can, but we’ll let Carlos have his moment). Start taking care of your future self today. Say bye to coulda, woulda, shouldas. Cryptocurrency wealth builders to get started.


Subscription received!

Please check your email to confirm your newsletter subscription.

Leave a Reply

Your email address will not be published. Required fields are marked *