How to Build a Complete Investment Portfolio
Financial planning for your future can be challenging as there are so many variables that come into play. Inflation, changing needs, evolving lifestyles and habits, family responsibilities, health concerns, attitudes, and more can impact your future financial requirements. Investing can help cater to all of these needs. However, building an investment portfolio that can comfortably accommodate your future necessities is essential. Investing can help you counter inflation, save beyond your salary, and plan for goals that may seem out of reach right now. It can allow you to fulfill your present goals and plan for the future without burdening yourself with money issues. However, creating the right investment portfolio that can suit your budget, risk appetite, and preferences is essential. There is no definitive rule book that can help. However, there are specific steps that you can take to ensure that your personal investment portfolio is comprehensive and does not lack anywhere. This can ensure that you meet your goals at your preferred time horizon and do not stress over the finer details. If you wish to create an investment portfolio that best suits your needs, risk profile, and investment horizon, consult with a professional financial advisor who can advise you on the same. This article talks about some checklists you can keep in mind while planning for your future goals.
How to build an investment portfolio
Here are some things you can pay attention to when creating an investment portfolio:
1. Understand your risk profile and target asset allocation:
Risk refers to the uncertainty involved in investment. All investments can carry some amount of risk. However, the precise percentage can differ for each instrument. Typically, the risk is categorized into high-risk, low-risk, and medium-risk. The first step in creating an investment portfolio is to assess your risk appetite. This enables you to make a target asset allocation for your portfolio. There are different asset classes that you can invest in, such as stocks, bonds, gold, real estate, and more. Each of these caters to various risk appetites and can deliver returns accordingly.
Typically, high-risk investments can provide higher returns in comparison to others. Likewise, low-risk options give relatively lower returns, and medium-risk investments offer moderate returns. However, the choice between the three is not as easy to make. If you are nearing retirement, carrying too much risk can be detrimental. So, in such a case, keeping a low to moderate risk can be more suitable, even if the returns are low. However, if you are aggressively saving for something and have a long investment horizon, you can opt for high-risk options as potential losses can be overturned by profits along the way.
Most financial experts recommend a mix of all assets – stocks, bonds, and others. This offers you exposure to all options and minimizes risk. The asset allocation can differ based on your age and goals. A general formula that most investors use to determine this is to subtract your age from 100. The answer would be your stock allocation, and the remaining can be your allocation in bonds and other options like cash and cash equivalents. For instance, at the age of 40, you can have 60% of your investments in stocks and 40% in bonds and others. At 50, you could move to a 50:50 ratio, and so on. This does not apply to everyone but can serve as a general guide for you. Your risk appetite decreases as you age, which is why this formula can be helpful.
2. Invest in employer-sponsored retirement plans:
The 401(k) is a popular employer-sponsored retirement plan that can help you save for the future. It is an integral part of a financial portfolio and can immensely benefit you in the long run. A 401(k) is a tax-advantaged plan meant for retirement savings. You can contribute to it as per the limits set by the Internal Revenue Services (IRS) every year. For 2022, you can contribute up to $20,500 per annum. For those over the age of 50, there is a catch-up contribution of $6,500, bringing the total to $27,000 for the year. The most significant benefit of a 401(k) is the employer match. There is an employer match for every dollar contributed to a 401(k) by the employee. The total contribution for both employees and employers is $61,000 in 2022. The employer may or may not contribute to the total limit, but this can be a substantial additional income for you irrespective of what they choose. There are two types of 401(k)s:
- Traditional 401(k): You can contribute your pre-tax dollars here, so your contributions are not taxed. This helps you lower your taxable income in the present. However, your retirement withdrawals are taxed as per the income tax slab you qualify for in the future. You can opt for this if you are likely to be in a lower tax bracket in retirement.
- Roth 401(k): A Roth 401(k) account is the opposite of a traditional one. It allows you to contribute your after-tax dollars, so your contributions are taxed now. This may increase your taxability in the present, but your withdrawals will be tax-exempt in retirement. This is suitable if you expect to be in a higher tax bracket in retirement.
3. Consider an Individual Retirement Account (IRA):
An IRA is similar to a 401(k). The only difference is that an IRA is not company-sponsored. You can set it up with a financial institution like a bank, credit union, or broker. If your employer does not provide a 401(k), an IRA can be an alternative. In 2022, you can contribute up to $6,000 if you are under the age of 50 or $7,000 if you are 50 years old or more. Just like a 401(k), an IRA also has two types –Roth and traditional. The taxability for these is the same as a Roth 401(k) and a traditional 401(k).
4. Diversify your investment portfolio:
Diversification refers to investing your money in different types of investments and asset classes to lower risk. No two investments are likely to react the same in the face of market volatility. So, putting your money across different options helps you secure your capital. For instance, if you are investing in stocks, try to include stocks of different sectors in your investment portfolio. In 2020, tourism took a massive hit. But pharmaceuticals, gold, essential items, and more saw a boost. Concentrating on only one sector can significantly impact your investment gains, but distributing your money helps to control the effect of market volatility. When diversifying your portfolio, try to keep a negative correlation between options so when one moves down, the other moves up. If you do not know or understand how to diversify your investments yourself, you can opt for mutual funds or exchange-traded funds that offer optimal diversification. A financial advisor may also be of use here. So, you can consider hiring one.
5. Track the performance of your investments:
Your personal investment portfolio should align with your needs and goals at all times. This is why building a portfolio is not a one-time thing. It requires time, effort, and attention. Tracking the performance of your investments can help you understand your money better. It can enable you to take swift decisions when required and adjust your investments as per your changing requirements, inflation, and prevailing market opportunities. However, the critical thing to note here is that tracking your assets does not have to mean stressing over them. Your money is expected to move up and down, especially in equity markets that can be highly volatile. This is normal as the market works in a cyclic manner. So, jumping at first sight of a market downturn may not be advised. However, if your investment has been consistently underperforming, you can consider a change. Being able to effectively monitor your investments gets easy with time and knowledge. So, try to learn as much as you can about the investments you choose. This will help you adjust your expectations and offer clarity on what to do in an unfavorable situation.
A central component of tracking also involves rebalancing your portfolio. Rebalancing refers to bringing the target asset allocation of your portfolio back to what it was. Market movements, inconsistent returns, and other factors can bring an imbalance to your original asset allocation. For instance, if your equity investments do better than debt, your stock allocation may increase to more than 60%, as you earlier set it. In this case, your exposure to risk will also rise. If your risk appetite does not permit you to take on as much risk, you can sell some of your stocks and invest that money in bonds to bring your asset allocation back to 60:40. You can rebalance your portfolio every six months to a year. You can also work with a personal financial advisor for professional guidance and advice in this area.
6. Be consistent when it comes to investing and saving money:
A single lump sum investment may or may not offer you the desired returns, but consistency can. It can be hard to plan for a time in the future with a limited salary. However, disciplined investing can help. It is vital to invest and save regularly, so the burden of planning for the future does not take a toll on you. Making savings and investment a priority can help you reach your goals with much more ease. The sooner you start investing, the more time you have on hand to achieve your desired target. Moreover, consistency also ensures that you are able to plan for several goals at once. An average person can have goals like retirement savings, savings for a child’s higher education, home purchase, health expenses, and more. All of these can be impossible for a middle-income person to cater to at once. However, if you invest in dedicated investment options for each of these goals, such as a 529 savings plan for your child’s future expenses, a Health Savings Account (HSA) for your health expenses, a 401(k) or an IRA for your retirement expenses, you may be able to tackle all your needs at once. Moreover, slowly but steadily, you will be able to gather enough funds for each goal.
Other crucial tips that you can pursue alongside creating an investment portfolio:
- Pay off your debt as soon as you can. This will help you focus on your future rather than paying off your past expenses.
- Build an emergency reserve for unexpected eventualities like a job loss, home repair, health emergency, business loss, and more.
- Work with a professional financial advisor for experienced advice in managing your finances. A lot of people follow the advice of their peers and friends, which may or may not work for them. However, opting for professional help ensures you get customized advice that is suited to your unique concerns and goals.
- Try to find additional sources of income.
- Be patient and realistic when setting goals and expectations. This will help you maintain peace of mind.
Building an investment portfolio can require time and patience. However, as long as you follow the proper steps and ensure that your portfolio reflects your wants and goals, you can be on the right track. It may not be advised to follow other people’s footsteps or mimic their moves, as your financial journey is going to be different from theirs. What does help is understanding your goals, risk, and time horizon and then investing your money suitably. For more clarity, you can also rely on the expertise of a financial advisor.
Building a complete investment portfolio requires a deep understanding of the investor’s risk appetite, financial goals, retirement needs, investment horizon, and more. Use WiserAdvisor’s free advisor match service to find highly qualified and vetted fiduciary advisors who match your needs. Answer a few questions about yourself and get matched with 1-3 fiduciary advisors that are suited to meet your financial requirements.