If you have any financial assets, you have a portfolio, whether you realize it or not. A portfolio is a collection of all the assets you own. Financial assets such as stocks, bonds, and cash are all parts of your investment portfolio, which may also include other assets like real estate.
How Does an Investment Portfolio Work?
An investment portfolio can help you grow your wealth to achieve future goals such as a strong retirement fund. The basic idea is that you buy investments that increase in value, thus making money.
Asset Allocation
The way you choose to invest assets in your portfolio, or the types of assets you buy, is called “asset allocation.” Assets primarily fall into three categories: stocks, bonds, and cash or cash equivalents like savings accounts and money market accounts. Within each main category, you have many options. For example, individual stocks, exchange-traded funds (ETFs), and managed mutual funds.
Portfolio Diversification
To avoid excessive exposure to losses in one company or industry, you can also choose to diversify your portfolio by buying a number of investments across various asset categories.
Types of Investment Portfolios
You may already have an investment portfolio in the form of a retirement account through your employer. Some may have portfolios in which they buy and sell assets with the aim of making short-term profits. Some people invest to achieve medium-term goals, such as buying a home. Others may have several portfolios designed to meet a range of objectives.
There are a few different types of investment portfolios. Each type relates to a specific investment goal or strategy and a level of comfort with risk.
Growth Portfolio
A growth portfolio, also known as an aggressive investment portfolio, involves taking on a higher level of financial risk in exchange for the potential for higher returns. Many investors in a growth portfolio seek out new companies that need capital and have growth potential, rather than older, more stable companies with a track record (and less growth potential).
Investors in a growth portfolio are willing to cope with short-term fluctuations in the underlying value of their assets if it means more opportunities for long-term profitability. This type of portfolio is ideal if you have a high capacity for risk or if you wish to invest for the long term.
Income Portfolio
An income portfolio is built with a focus on generating consistent, passive income. Instead of seeking investments that might lead to the greatest capital gains over the long term, investors look for investments that pay steady dividends with low risk to the underlying assets that earn those dividends. This type of portfolio is ideal if you want to avoid risk or if you plan to invest for a short to medium timeframe.
Value Portfolio
A value portfolio consists of stocks that are undervalued relative to the overall financial picture of a company. Investors in a value portfolio buy those stocks that are priced below their true value and then hold them until their prices rise.
Rather than focusing on income-generating stocks, investors in a value portfolio buy stocks to hold for the long term with the aim of growth over time. This type of portfolio is ideal if you have a moderate risk tolerance and a long timeframe.
Defensive Portfolio
Defensive stocks are those that have relatively low volatility in an industry or sector that generally remains stable despite changes in the wider market. In other words, defensive stocks represent those companies whose products have consistent demand, regardless of the state of the economy.
A defensive portfolio consists of low-volatility stocks with the intent to minimize losses in the event of a market downturn. Defensive portfolios typically feature lower risks and lower rewards. These portfolios tend to perform well over long timeframes, as they result in smaller but sustainable growth.
Portfolio
Balanced
The balanced portfolio is considered one of the most common options used by investors. This type of portfolio aims to reduce volatility. It mainly contains income-generating and moderately growing stocks, along with a significant proportion of bonds. A mix of stocks and bonds can help reduce risks regardless of market direction. This type of portfolio is ideal for someone with a low to moderate risk tolerance and a medium to long time horizon.
Note: You are not required to stick to just one of these strategies. A good diversified portfolio can include a mix of growth stocks, dividend-paying stocks, value stocks, and defensive stocks.
Do I need an investment portfolio?
If you currently do not have an investment portfolio, you may wonder if you really need one. After all, isn’t the stock market fraught with risks?
A public opinion survey in 2020 found that only 55% of Americans owned stocks. This percentage has remained roughly stable over the past decade. The survey also found that about half of the respondents (48%) believed it was bad to invest an additional $1,000 in the market, while the other half (49%) thought it was good.
Of course, there are many reasons why people may hesitate to build an investment portfolio. They may need the money to pay for other things, such as daily necessities. Or they may see the market as risky. They may even be cautious about the learning curve that comes with investing. Although these concerns are valid, building an investment portfolio is one of the best ways to grow your wealth and achieve your key financial goals and secure retirement.
Investment Portfolio vs. Savings Account
People often use the terms “savings” and “investment” interchangeably. For example, we might talk about saving for retirement in a 401(k) account when we actually mean investing for retirement.
While your savings account is a part of your overall portfolio, investing and saving are two completely different strategies.
Investing
- Done in a brokerage account
- Involves some risk of financial loss
- Higher financial returns
- Better for long time horizons of 3 to 5 years or more
- Protects against inflation
Saving
- Done in a bank account or credit union
- Free from the risk of loss as long as the bank is FDIC insured
- Lower or no financial returns
- Better for short time horizons
- Does not protect against inflation
Note: Low-risk assets like savings accounts are a key part of a good diversified portfolio.
How to Build an Investment Portfolio
- Decide whether you want to manage your portfolio yourself or hire a professional
- Consider your time horizon
- Determine your risk tolerance
- Focus on diversification
- Rebalance as needed
Summary:
- A portfolio is a collection of financial assets owned by an investor, which can include stocks, bonds, real estate, cash, and more.
- An investment portfolio works by purchasing investments that increase in value, thereby generating profit.
- There are several types of investment portfolios, including growth portfolios, income portfolios, value portfolios, defensive portfolios, and balanced portfolios.
- Creating an investment portfolio is one of the best ways to grow your wealth and achieve your key financial goals.
- Saving and investing are two different strategies, and each can play an important role in your overall portfolio.
- You can build an investment portfolio by determining how to manage it, considering your time horizon, assessing your risk tolerance, focusing on diversification, and rebalancing as needed.
Source: https://www.thebalancemoney.com/what-is-a-portfolio-5091720
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