One of the basic investment tools that you will be using as a new investor is your portfolio. A portfolio is not exactly a physical thing as far as investing is concerned but instead is the term used for a collection and combination of different investment assets. Any asset that you own, from stocks and bonds to equities, art, real estate, fixed income instruments and so forth make, up your portfolio and are used to achieve any investing goal that you may have.
You can think of your portfolio in the same way you think of a pie chart, where different portions of the chart represent a different asset and a different percentage of your portfolio. The entire pie makes up your portfolio and, depending on the strategy that you have, the return that you expect to make and the risk that you willing to take, you will mix and match the assets in your portfolio accordingly.
Your portfolio is thus made up of different types of assets and those assets will have different returns and different levels of risk. If you have a strategy that involves aggressive investments, you will have a portfolio that includes investments that will, if things go well, give you the highest possible return but, on the other hand, if things don’t go well can also cause you to lose the most (because they are the highest risk). Most portfolios that are built using an aggressive strategy include a high percentage of equities.
A strategy that is more conservative, and thus puts a higher priority on lowering your risk and increasing your “safety net”, will generally be made up mostly of cash, cash equivalents and high-quality fixed income investment instruments. Conservative portfolios are usually put together by investors who want to keep their risk as low as possible as well as investors who have a shorter time horizon and want to maximize their returns in a shorter period of time.
In general, a conservative portfolio’s goal is to maintain the real value of the assets included in the portfolio as well as protecting those assets from inflation. Most portfolios of this type are put together so that they will yield a certain amount of current income as well as long-term capital growth.
If you are an investor with a longer time horizon and a little bit higher risk tolerance, a moderately aggressive portfolio is probably for you. Moderately aggressive portfolios balance risk with returns and, while the returns are less than an aggressive portfolio, the risk is also less.
Then of course there is the aggressive portfolio that we’ve already mentioned and, while the risk for this type of portfolio is the highest the return is also the highest. Most high risk portfolios are using a strategy that focuses on short-term investing with higher (possible) returns.
What all portfolios have in common is the need for careful diversification. Diversification simply means that a portfolio consists of different assets so that, if one of those assets happens to lose value or, in some cases, become completely worthless, the entire portfolio won’t be devastated. The fact is that at any point in time your assets and investments will perform differently and, if you have a mix of several asset types in your portfolio, when one of those assets suffers the entire portfolio (in general) will not.
Over the last several decades there have been numerous academic studies about why diversification is vital to the return on any portfolio as well as lowering said portfolio’s risk. At the end of the day however it simply a matter of following the old adage “never put all of your eggs in one basket”. Spreading the investments in your portfolio across different markets and different assets will thus greatly reduce the chance that your portfolio will suffer a catastrophic financial loss (i.e. you lose everything).
If you’re a new investor and you have questions about building a portfolio, what the different types of assets are and how to best diversify, please let us know and we will get back to you with advice, suggestions and answers.