There are many different strategies when it comes to creating a portfolio of investments. Usually a portfolio is created by a broker or financial advisor but for those that are curious here are some concepts that might come in handy especially for people who are interested in managing their own investments through an online investing account.
The basics are very simple and so is the logic that revolves around how assets are chosen and what proportion of the portfolio is assigned to each type of asset. Remember that risk tolerance is different for every individual and that for this reason a beginner should seek help from a professional advisor. A very basic and simple investing portfolio is composed of three different types of assets. These assets are bonds, stocks and of course cash. The idea is to determine what percentage of the portfolio will be assigned to each type of asset. For example, a relatively young person in his or her 20s may want to have 85% of the money in stocks 10% in cash and 5% in bonds. This person is relatively young and has a lot of time to recuperate if his or her portfolio is wiped out. People in their 50s may opt for a portfolio that has less money invested in stocks and more money in the form bonds. A person with more than 50 years would provably feel safer with assets that are less risky and less volatile like government bonds and of course cash. This is a very simple example but the idea is that risk tolerance is not the only thing that can affect the structure of a portfolio, age and other factors should also be taken into consideration.
Usually, when using portfolio planner applications that are offered as services in an online investing account the investor will notice that the asset allocations that are provided by the planner differ a lot depending on the type of portfolio chosen and have labels like: aggressive growth, moderate growth, growth, capital preservation and other such labels. An investing plan considered to fit under the aggressive growth label will consist mostly of stocks, especially small caps and mid cap stocks from companies that are in their growth phase. The thing is that this type of asset is riskier because a small growing company may either grow very quickly at unbelievable rates or may never make it at all. On the other hand, a growth strategy that is not as aggressive may advise the investor to buy more stocks from large cap companies that are considered “blue chips” like Microsoft, IBM, Johnson and Johnson, McDonald’s among others and less from aggressive growth small cap companies. These are companies that may still grow and many times are reliable dividend stocks but they may not grow as quickly as smaller companies. The real difference relies on the type of company and not the type of asset since shares from a small company and shares from a huge and established company are still stocks. However, the difference in volatility between a small cap startup and a company that is established like IBM is huge. For this reason it is very important for the investor to consider his or her risk tolerance and get to know his or her investing temperament before going too aggressive.
On the other hand, conservative portfolios tend to focus more in bonds that in stocks and are sometimes known as capital preservation portfolios. These are made most of the time with retired people or those close to retirement in mind and the idea behind them is to like the name says, preserve capital and at the same time generate a steady income that the investor can use to cover other things in life without running out of money. Bonds are considered a less risky investment than stocks especially tax free treasury bonds. This is the reason why conservative strategies advise to have a large percentage of assets in the form of bonds.
Some advisors suggest to people that are young to start with an aggressive growth or moderate growth strategy and as they approach retirement to move to a more conservative strategy like a balanced or a capital appreciation portfolio. The philosophy behind this is that, like mentioned at the beginning of the article, a young person has plenty of time to rebuild his or her wealth but a person near retirement that loses a lot of his or her portfolio has little time to make up for the loss before retirement age.
Note: This article very basic and the goal here is to help the reader understand what an investment portfolio is along with some basic concepts. There are many types of assets that a person can invest in like commodities, investing through a mutual fund, buying ETFs and many others. A true diversified portfolio holds investments reaching out to different types of assets to reduce risk and doesn’t rely only on ones judgment but also takes advantage of other people’s knowledge like in the case of investing in professionally managed mutual funds.