What Is Portfolio Investment? An In-Depth Guide
An investment portfolio is a set of financial products with a strategic asset allocation of each of them. A smart investor takes a diligent and disciplined approach to invest their money in financial assets that minimize their risk and reward them with good returns.
Portfolio investments may include a wide range of financial assets like stocks, futures, and options, derivatives, Real Estate Investment Trusts (REITs), mutual funds, government bonds, Exchange-Traded Funds (ETFs), corporate bonds, physical instruments like gold, commodities, rental properties, etc.
An investor should not invest in too many assets and should keep a few crucial factors in mind before creating their portfolio.
Factors Determining Asset Allocation in a Portfolio
**Investor’s risk tolerance: **This is the level of uncertainty (in terms of returns) that one can handle while investing in a particular asset. Those with a lower tolerance for risk should invest in less volatile products like government bonds and mutual funds, while those with a higher tolerance for risk should allocate their funds in real estate, equity market, etc.
Investor’s age: This plays an essential role in deciding fund allocation in different assets. Young investors (those in the age bracket of 25 to 35 years) may have a higher allocation rate in equity, whereas those who are nearing their retirement can have higher asset allocation in safer instruments like debts and bonds.
Amount to invest: It is the surplus money available to an investor for a portfolio investment. Generally, younger investors in the early stages of their careers have a smaller amount available to create a portfolio as compared to those who have been earning for many years.
Investment horizon: It is the time period for which the investor will stay invested in a particular financial product. For a longer investment horizon (say, 30 years), investing in riskier assets like equities may give good returns, whereas, for a shorter horizon, fixed income assets like government bonds are a better choice.
As a rule of thumb, the higher the risk in an investment is, the higher the expected returns will be from it and vice versa. Thus, it is necessary to implement strategic asset allocation in those financial assets which help the investor optimize the risk and reward in his investment portfolio.
The investors can allocate their assets strategically with the help of a diversified portfolio.
Going by traditional wisdom, an investor should not put all their eggs in one basket, i.e., they should not invest in only one financial product or asset class as there’s a risk of financial losses in case that one asset class or product does not perform well. But investing only in safe assets like government bonds, PPFs, NSCs, etc. is not the best option either as these investments will give limited returns. Thus, investors should include some high growth-oriented assets like equities as well in their portfolio to manage risks and returns together.
A diversified portfolio with strategic asset allocation in different asset classes will ensure good returns with a reasonable level of risk.
Here are a few common strategies to diversify your investment portfolio:
The Aggressive Investment Strategy
It is primarily a stock portfolio that will have significant asset allocation in stocks with very little investment in bonds or cash. It is created with the objective of getting maximum returns by taking a high degree of risk. The investor needs a high tolerance for risk and a long investment horizon to get good returns from this strategy.
The Moderate Risk Investment Strategy
It is a stock portfolio that will mainly invest in stocks that give stable returns with consistent dividends, irrespective of the volatility in the overall equity market. These stocks provide an extra level of protection against market fluctuations while offering moderate returns. Investors with moderate risk tolerance and a long investment horizon can consider portfolio investment using this strategy.
The Speculative Investment Strategy
A speculative stock portfolio is the riskiest investment strategy as it invests in IPOs or stocks that are anticipated to give good returns. Investors tend to get allured by high returns in a short period of time by investing in a speculating portfolio, however, a lot of homework and research is required to get good returns with this strategy. Investors with a high-risk tolerance and a very low investment horizon may consider trading in stocks with this strategy.
The Income-Producing Investment Strategy
An income-producing stock portfolio focuses on making money through dividend offering stocks or Real Estate Investment Trusts (REITs). The investors earn returns in the form of capital gains and high dividends. This strategy is the best bet for investors looking to supplement their paycheck or building an income source after retirement.
The Hybrid Investment Strategy
This stock portfolio is the most balanced one with investment in different asset classes like bonds, commodities, and real estate with quality stocks like blue-chip stocks in relatively fixed proportions. This diversification strategy ensures a balance between equities and fixed income securities to mitigate risk and maximize profits. An investor with in-depth knowledge about multiple asset classes may create this diversified portfolio or take the help of a professional advisor.
A Word of Caution
Many investors tend to believe that adding more and more assets to their portfolio will fetch them better returns. But this is far from the truth. According to financial experts, having 15-20 stocks from different sectors would be sufficient to create a well-diversified portfolio. In fact, an over-diversified portfolio will do more harm than good as it will negate the good returns from some assets with losses from others giving average or negative returns.
The Bottom Line
With so many different financial products and asset classes to choose from, an investor needs to apply their knowledge and wisdom and employ strategic asset allocation while making portfolio investment. If doing it by themselves, they will need to monitor their portfolio regularly to make any adjustments required in asset allocation in order to get good returns from their investment
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