A portfolio’s meaning can be defined as a collection of financial assets and investment tools that are held by an individual, a financial institution or an investment firm. To develop a profitable portfolio, it is essential to become familiar with its fundamentals and the factors that influence it.
What is a Portfolio?
As per portfolio definition, it is a collection of a wide range of assets that are owned by investors. The said collection of financial assets may also be valuables ranging from gold, stocks, funds, derivatives, property, cash equivalents, bonds, etc. Individuals put their money in such assets to generate revenue while ensuring that the original equity of the asset or capital does not erode.
Depending on one’s know-how of the investment market, individuals may either manage their portfolio or seek the assistance of professional financial advisors for the same. As per financial experts, diversification is a vital concept in portfolio management.
Components of a Portfolio
The major components of an investment portfolio are described below –
||Stocks||Stocks refer to company shares and the investors’ ownership of the same. Notably, the percentage of ownership depends on the number of company stocks held by an individual. The stockholders are entitled to a share of the company’s profits, and they avail it in the form of dividends.
Investors can further generate higher returns on their investment in stock by selling the same at a higher price. Stocks are considered to be the reward generating component of an investment portfolio. However, they come with a significant risk factor.
||Bonds||Bonds come with a maturity date and are considered less risky than stocks. On maturity, investors receive the principal investment amount along with interest. Bonds constitute the risk-cushioning aspect of an investment portfolio.|
||Alternatives||Besides stocks and bonds, investors can also add alternative investment instruments like oil, real estate, gold, etc.|
Types of Portfolio
Though there are several types of investment portfolios, investors make it a point to build one that matches their investment intent and risk capacity.
Based on investment strategies, these following are some common types of portfolios –
1. Income portfolio
This type of portfolio emphasises more on securing a steady flow of income from investment avenues. In other words, it is not entirely focused on potential capital appreciation.
For instance, income-driven investors may invest in stocks that generate regular dividends instead of those who show a track of price appreciation.
2. Growth portfolio
A growth-oriented portfolio mostly parks money into growth stocks of a company who are in their active growth stage. Typically, growth portfolios are subject to greater risks. This type of portfolio is known for presenting high risk and reward aspects.
3. Value portfolio
Such a portfolio puts money into cheap assets in valuation and focuses on securing bargains in the investment market. When the economy is struggling, and companies are barely surviving, value-oriented investors look for profitable companies whose shares are priced lower than their fair value. When the market revives, value portfolio holders generate substantial earnings.
Investors must note that several factors tend to influence how one decides to build a portfolio.
Factors that Affect Portfolio Allocation
These following factors tend to influence an investor’s portfolio allocation to a great extent –
1. Risk Tolerance
Investors’ risk appetite impacts how they are going to allocate their financial assets and investments into their portfolio. One can quickly gauge the risk tolerance level of an investor from the component of their portfolio.
For instance, conservative investors are often more inclined to build a portfolio that comprises large-cap value stock, investment-grade bonds, cash equivalents, market index funds, etc. Conversely, individuals with a high-risk appetite may include investments like small-cap and large-cap growth stock, high-yield bonds, gold, oil, real estate, etc. in their portfolio.
2. Time horizon
The time-frame of putting money on a particular investment option is also quite crucial for building a profitable portfolio. As the general rule suggests, investors should modify their portfolio to achieve a conservative asset allocation mix as they approach nearer to their financial goals. It is followed to prevent accumulated earnings of their investment portfolio from eroding.
Typically, investors who are nearing their retirement are recommended to invest a more significant portion of their portfolio in less risky assets like – cash and bonds and the remainder in higher-yielding options. On the other hand, those who have just begun their career are suggested to invest the larger portion of their portfolio into high risk-reward investment options for the long haul. A longer time frame will help them to ride out the short-term market fluctuations and losses.
Other than this, investors’ financial goal is another important factor that influences the portfolio allocation. To elaborate, those with long-term goals are more likely to invest in long-term investment options like – equity funds, ULIPS, stocks, debt mutual funds. Alternatively, those with short-term goals tend to prefer liquid mutual funds, recurring deposits, government bonds, treasury bills and more.
Need for Portfolio Management – In a Nutshell
With the help of sound portfolio management, investors can build the best investment plan that matches their income, financial goals, age and risk capacity.
These pointers below highlight the underlying need for active portfolio management –
- It helps to cushion investment-oriented risks and increases the scope of generating more profits.
- Helps to develop sound strategies and rebalance asset composition as per their current market condition so that investors can make the most of existing investment.
- It enables quick customisation based on immediate financial needs and market conditions.
- Helps understand which investments work best under which market situation and how to distribute resources into different asset classes.
The best way to build a sound investment portfolio is by determining its financial objective and rebalancing its components frequently. Subsequently, investors should focus more on diversifying their resources to attain the best possible rewards at manageable risks in all situations. In case individuals lack the farsightedness or market knowledge to manage a portfolio, they should seek a professional opinion.