How to Build Your Investment Portfolio:
How you invest your money can shape how you build your future. This is true whether you are in your 20’s and just starting to save for a new home or in retirement and managing your money through your golden years. Creating an investment portfolio may be one of the most important things you will do to determine your financial success. With literally tens of thousands of stocks, bonds, mutual funds, ETFs and other investment options to choose from, where should you start?
As I see with investors on a regular basis, building the portfolio can be daunting. It is similar to renovating a house and not knowing where to start. Do you meet with the contractor or the architect first? Do you include a decorator now or later? Do you move out or do you stay put? How do you balance all the steps that have to take place to make the project run smoothly and efficiently? As with any daunting project, the best thing to do is to break it down into steps. Here are some fundamental and easy steps to follow when building your investment portfolio to simplify what can often feel like an overwhelming task.
Separate saving and investing. Think about your big picture financial goals. Are you saving for a new house or putting money aside for retirement. Separate the goals into short term and long term goals. Any money you’ll need in the next five years should go into savings, not the stock market. The market is too risky and volatile in the short term. If you plan to buy a house in the next couple years, keep the down payment in a savings account. Amounts set aside for retirement and maybe vacation homes long into the future can be invested. Only put money in the market if you’re able to leave it there for 5 years or more.
Gauge your risk tolerance. Investing is a balancing act – the more risk you’re willing to accept, the higher long-term returns you hope to receive. Can you stomach big ups and downs in the market? Can you leave money invested for many years? If so, your portfolio can be on the more aggressive side. Are you close to or in retirement and need the money for ongoing living needs? If so, your portfolio may need to be on the more conservative side (less risky).
Get the mix right. Risk and return and return are related. Historically, equities have offered higher return with more risk. Bonds are generally less risky, but returns are typically less. Bonds benefit the portfolio by managing the volatility you see in the equity markets. The right mix for you is the one that provides enough return to meet your goals, without being so risky that you can’t sleep at night.
Diversify. Don’t put all your eggs in one basket – this well-worn nugget of wisdom never goes out of style. Using low-cost mutual funds, will spread your equity exposure across multiple asset classes. Balance out your exposure to large company stocks by adding a portion of your portfolio to small companies. International companies add another level of diversity to your domestic stocks. Add in real estate through a well-diversified real estate investment trust. Build your bond component using a variety of high quality, short-to-intermediate term bonds. Don’t let any single holding dominate your portfolio.
Stay in balance. The most reliable predictor of your investment results is overall allocation and your ability to stay disciplined. Once you’ve built a diversified and risk-appropriate portfolio, the key is to keep it that way. As different elements of your portfolio advance at different rates, your 70-30 allocation of stocks to bonds, for example, may drift to 60-40 or 80-20. Get back in balance by selling some of your best performers and spreading the gain across securities that have lagged. That’s selling high and buying low.
Step away. Avoid the news we hear daily in the news. The biggest mistake most investors make is letting emotions override discipline. It’s extremely important to not tweak and tinker with holdings with every scary headline and market swing. Remember, investing is for the long term. Buy, hold, rebalance, and let the market work for you over the long-term.
As with your renovated house, if you take the time to lay out the steps, you can come away with a successful project. The same is true for building your portfolio. The steps above should help you get your arms around the important task of investing. If you can layout your goals, review your risk tolerance, diversify your portfolio and tune out the noise, you will have a great start to the portfolio that will help you build your dreams.