No two investors have the exact same investment goals. Building a portfolio that is customized to your comfort level and consistent with your goals can be a very difficult task. Many different factors have to be taken into consideration to assure that your portfolio is well diversified.
Generally, six factors are used in the portfolio construction and management process for individual investors: time horizon, liquidity, marketability, tax consequences, risk tolerance, and diversification. These are the most common factors also used in selecting the most suitable investment vehicles for any investment strategy, such as saving for goals such as retirement or college funding. Let's take a closer look at what each factor means:
Time horizon can be defined as the investment holding period, or the time in which a specific financial goal is expected to be attained.
Risk tolerance level
In general, the risk tolerance level is an intangible and subjective factor based upon the your emotional temperament and attitudes.
The primary function of diversification is to reduce risk exposure by constructing a portfolio with investments that are not affected by the same investment risks.
Liquidity is the ability to readily convert an investment into cash without losing any of the principal invested.
Marketability is the degree to which there is an active market in which an investment can be traded.
Tax consequences have to be considered when making investment selections. For example, In an IRA, the yield on public purpose municipal bonds is unacceptably low because the income's tax-exempt nature is of no value to an already tax deferred investment vehicle.
If building a portfolio is beginning to sound complicated, that's because it can be. What's more, the investment selection process is not a one-size-fits-all process. Your portfolio should obviously match your goals and the degree to which you are willing to accept investment risk. Don't be fooled by advice suggesting your age dictates how your investments should be allocated, much more goes into the selection process than just your time horizon. So, before you start determining what percentage of your money should be in equities, fixed income or cash, you should probably call your investment professional.
The author is a CLU and ChFC designee, a Registered Investment Advisor and registered representative of Jefferson Pilot Securities Corporation, member NASD, SIPC.