An investment portfolio is a collection of assets like stocks, bonds, mutual funds, exchange-traded funds (ETFs), real estate, and cash equivalents. Investors can have multiple portfolios—such as a taxable investment portfolio in a brokerage account and a retirement portfolio in a tax-advantaged 401(k). However, the goal of all investment portfolios is the same: to put your money to work and potentially build wealth.
Types of investment portfolios
A sound investment portfolio will be diversified—meaning you don't put all your eggs in one basket. How you diversify depends on your investment goals, risk tolerance, and time horizon. Here are five broad types of investment portfolios.
Growth portfolio
A growth portfolio is a high-risk, high-reward investment approach. Growth portfolios are appropriate for younger investors who have the time to ride out market fluctuations and losses. They're also suitable for investors who want to grow their assets quickly and are comfortable taking risks. These portfolios may include domestic, international, and emerging market stocks and speculative investments like cryptocurrencies.
Income portfolio
An income portfolio focuses on generating reliable income from investments like dividend-paying stocks and real estate investment trusts (REITs). These portfolios are best for investors prioritizing a steady stream of investment income over capital appreciation.
Value portfolio
Value portfolios contain value stocks—stocks that are priced low relative to their fundamentals and peers. The goal of a value portfolio is long-term growth, so it's ideal if you have a long time horizon and moderate risk tolerance.
Defensive portfolio
A defensive (aka conservative) portfolio focuses on low-risk, low-reward investments like blue-chip stocks, debt securities, and cash and cash equivalents. Risk-averse investors are good candidates for defensive portfolios, which prioritize safe returns over large earnings.
Balanced portfolio
A balanced portfolio contains a mix of stocks and bonds to reduce potential volatility. This type of portfolio is ideal for investors with mid- to long-range time horizons who are comfortable with short-term price fluctuations.
What are typical assets in a portfolio?
An investment portfolio can hold various assets suitable for the investor's goal, risk tolerance, and time horizon. While portfolios commonly have stocks, bonds, and funds, they can contain any type of investment—including commodities, cryptocurrencies, gold coins, real estate, wine, artwork, stamps, comic books, and other collectibles.
How to build an investment portfolio
Building an investment portfolio is one of the essential tasks of investing and building wealth over time. Here are the basic steps to help you get started.
1. Decide if you want help
Not everyone has the skill, time, or interest to build and manage an investment portfolio. If you're not much of a DIY-er, consider using a financial advisor like Empower to provide personalized financial advice and to help you choose the best investments.
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Fees
Managed accounts accrue an annual fee that’s charged quarterly and based on your assets under management (AUM). The rates are 0.50% for up to $100,000 in AUM, 0.40% for the next $150,000, 0.30% for the next $150,000, and then 0.20% for AUM greater than $400,000.
2. Consider your investment profile
Knowing your investment goals, risk tolerance, and time horizon will help you choose the best investments for your portfolio. Remember that you can have multiple goals, each with its own time horizon. For example, you could invest for a child's college tuition that's 15 years away, and for your retirement, which could be 30 years down the road.
3. Open an investment account
Depending on your goals, you might need more than one type of investment account. For example, you might want a regular brokerage account (such as TradeStation or M1 Finance) for your nonretirement goals and a tax-advantaged IRA to grow your nest egg.
4. Choose your investments
Once you open an investment account (or two), you can build your portfolio with assets that match your risk tolerance and time horizon. Common investments include stocks, bonds, mutual funds, index funds, ETFs, and REITs.
5. Determine the best asset allocation
Asset allocation refers to dividing your portfolio among different types of assets based on the amount of risk you’re comfortable with and your time horizon. A general rule of thumb is to subtract your age from 110 or 120 to determine how much of your portfolio should be in stocks versus other assets (100 used to be the starting point, but longer lifespans and rising healthcare costs have changed the formula). If you're 40, you might have 70% to 80% of your portfolio in stocks, with 30% to 40% left over for bonds and cash.
How to manage an investment portfolio
Most investment portfolios require periodic rebalancing to maintain the original allocation. For example, if your portfolio should be 70% stocks, and it bumps up to 75%, you can sell some of your stocks or invest in other assets to bring the allocation back to your intended range. Rebalancing can happen automatically if you have a robo-advisor (the advisor will rebalance the portfolio as needed). Likewise, target-date funds automatically rebalance to reflect your changing time horizon.
What to consider when building an investment portfolio
There are a lot of factors to consider when building an investment portfolio. Here's what to keep in mind.
- Your investment goals. Consider why you're investing, whether planning a family, saving for a child's education, buying a house, building a nest egg, or leaving an inheritance to your loved ones.
- Your risk tolerance. Higher-risk investments offer higher potential rewards, but the risk may not be worth it if it keeps you up at night. Be realistic about how much risk you're comfortable with, financially and emotionally.
- Your time horizon. Younger investors have years to ride out market volatility and recover from losses, so they can generally manage more risk. Lower-risk investments are more suitable for older adults with less time to bounce back from market downturns. You can rebalance your portfolio over time to reflect your changing time horizon.
Importance of diversification
Diversification is based on the idea that you shouldn't put all your eggs in one basket—or all your money in a single stock. It's essential because it lowers your portfolio's risk: A mix of stocks, bonds, funds, and other assets helps keep your portfolio healthy under various economic and market conditions. For example, bond yields typically fall when stock prices rise during bull markets. So, if you're losing money in bonds, the stocks in your portfolio can balance those losses—and vice versa.
Of course, diversification means different things to different investors, and there's no fixed formula to follow. Still, here are allocation examples based on risk tolerance, courtesy of Fidelity Investments:
| Aggressive | Growth | Balanced | Conservative | |
|---|---|---|---|---|
U.S. stocks | 60% | 49% | 35% | 14% |
Foreign stocks | 25% | 21% | 15% | 6% |
Bonds | 15% | 25% | 40% | 50% |
Short-term investments | 0% | 5% | 10% | 30% |
TIME Stamp: Consider taxes when building your portfolio
Choosing investments and determining the asset allocation are vital steps in building a portfolio. However, deciding where to keep those assets is also essential to minimize your tax burden. Consider holding tax-inefficient investments—including taxable bonds, REITs, and actively managed stock funds—in a tax-advantaged account, such as an IRA or 401(k). Meanwhile, your taxable brokerage account might be ideal for holding tax-efficient investments, such as ETFs, index funds, municipal bonds, and individual stocks you plan to keep for at least a year.
RELATED: Best Roth IRA Accounts
A financial advisor or tax specialist can help you choose the best tax strategy for your investment portfolio. You can also opt for tools such as Playbook.
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Frequently asked questions (FAQs)
How much of your portfolio should be in one stock?
Having too much of one stock can be risky. If the stock performs poorly, it can have an outsized effect on your portfolio. For example, say your portfolio is worth $50,000, and you have $25,000 of stock ABC. If stock ABC tanks, you could potentially lose half the value of your portfolio, which could be challenging to recover from. To avoid concentrated positions—and the risk they carry—it's generally recommended that single stocks represent no more than 5% of your portfolio.
How do you rebalance an investment portfolio?
There are two basic approaches to rebalancing. The first (and simplest) approach is to rebalance at regular intervals, such as once a year, every six months, or quarterly. This option can make it easier to stick to your investment plan during periods of extreme market volatility.
The second approach is to rebalance based on a specific tolerance threshold, such as when an asset class strays from your planned allocation by 20%. Many financial advisors recommend this strategy because it's objective and based on the asset's performance rather than an arbitrary date.
How much international stock should you have in a portfolio?
Markets outside the U.S. fluctuate differently from domestic ones, so owning domestic and international stocks can help diversify your portfolio and level out volatility. You can invest in international stocks by purchasing individual stocks or a fund, such as a broadly diversified index fund.
While there's no specific formula, many experts recommend investing at least 20% of your portfolio in international stocks and bonds. For even more diversification, consider investing 40% of your stock allocation in international stocks and up to 30% of your bond allocation in international bonds.
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