Not every investor is ready to risk his funds, especially when it comes to large sums of money. For some, a smooth growth of capital that covers inflation and provides a small but stable income is sufficient. For example, people resort to such investments in order to accumulate funds for the retirement or education of their children, i.e. for the purposes of 10-15-20 years perspective. The only correct course of action in this case – making an optimal investment portfolio.
What is an investment portfolio?
An investment portfolio is a set of financial instruments in which an investor invests his funds.
There are optimal and sub-optimal portfolios. A portfolio may be compiled by an investor himself or be guided by trading signals from experienced traders or special programs – robo-advisors.
Fundamentals of an Investment Portfolio
The most important aspects of making a portfolio are its purpose, the amount invested, and risk. They directly affect the next most important features – the timing and strategy of investment, and, finally, determine the structure (list of assets).
The optimal portfolio, in turn, is an ideal balance between all variables that allows you to achieve your goal within a set time frame.
The investment objective should always be realistic, that is, it should reflect a realistic ratio of the investment amount to risk. For example, you can not achieve a million dollars in 2 years by investing $150 in low-risk assets. At the same time, the higher the investment amount, the more financial instruments are available to the investor and the more diverse the portfolio structure may be. Moreover, the initial investment amount is less important than regular subsequent investments, thanks to which one may acquire new instruments and adjust the portfolio composition to the current market situation.
New assets should be acquired according to the chosen strategy. It may be passive, moderate, or active. In fact, moderate strategy, which is most interesting in the context of this paper, is a “golden mean” strategy ensuring low risk and sufficiently high return – from 10 to 50% per annum depending on investor’s activity and portfolio composition method.
In a moderate strategy, funds are usually invested in the following types of instruments: stocks and bonds of large companies (so-called blue chips), ETFs, mutual funds, futures and options (only through trust management), and several others.
What does an optimal long-term investment portfolio look like with a moderate risk attitude?
There is no ideal ratio of assets in a portfolio that can be advised to any investor as a “starting point” – the goal and amounts invested are too closely linked. In addition, the market is constantly changing, so even when copying other people’s knowingly successful portfolios one cannot always achieve the same level of return – there are too many variables in the “equation.
However, the absence of a universal solution for the average trader does not mean that there is no optimal portfolio for a specific investor. In order to create one, it is necessary to consider each of the above aspects, as well as to adhere to a number of basic tips and principles.
General principles of creating an optimal portfolio
- The “classical” ratio of instruments in a portfolio with moderate risks: from 30 to 40% – conservative instruments aimed at keeping money, up to 50% – in moderate instruments, capable of “covering” a small income for inflation and giving a small profit, and only the remaining 10-20% – in the riskiest, but profitable. For beginners, there is a simpler option: 80/20.
- You should not neglect diversification – the more different instruments you have, the better the balance. For example, 40% of conservative instruments do not have to be exclusively bonds of one company. It is much better if they are different assets, of different companies from, again, different countries. It is optimal if the total number of “parts” of the portfolio is 10-15. A smaller number significantly increases the risk that losses from loss-making instruments will not be covered by gains from profitable ones, while a larger number will make it more difficult to keep track of assets.
- When constructing an optimal portfolio, it is best to use one of the proven techniques suggested by experienced investors.
- A balanced portfolio can be selected by Robo-Advisor, a service available from most large brokers.
- To increase returns, even a moderate portfolio must be actively managed, periodically selling unprofitable assets and buying profitable ones, thus rebalancing.
By following these basic guidelines and starting with small amounts, even a novice investor will be able to balance his assets and generate income.