5 Tips for Creating a Well Balanced Investment Portfolio
The best investment portfolio can help you weather the storm of market volatility and achieve your goals without any digressions. But unfortunately, there is no such thing as the best investment portfolio. The ever-changing stock market makes it hard to follow a standard approach to investing. However, what does help is a well-balanced portfolio. A portfolio that has a favorable mix of all asset classes and reflects your needs, goals, age, etc., can be the perfect investment portfolio example for success.
There are multiple ways to create a well-balanced portfolio. Diversification, periodic rebalancing, consistent investing, and other such practices can help. However, you have to keep in mind your risk appetite at all times and balance your investments with different financial needs, keep your debt to the minimum, and keep finding ways to increase your income sources if you want to live a financially secure and comfortable life. If you need help with creating a diversified investment portfolio that suits your risk appetite, investment horizon, and future goals, consult with a professional financial advisor who can advise you on the same. You must also know that balanced asset allocation can mean different things to different people. A 60-year-old may find a portfolio leaning towards debt more balanced, whereas a 30-year-old will likely find more value in stocks.
Irrespective of your age or income, some tips can come in handy at different stages of your life to create a balanced portfolio. Find out more about this in this article.
What are asset classes?
Before you start looking for the ideal stock portfolio example, it is essential to know what a portfolio constitutes. An investment portfolio can contain different asset classes, such as equity, debt or fixed-income, cash and cash equivalents, real estate, etc. Each of these classes includes investment options that have similar characteristics. The tax treatment, return, as well as risk appetite for each asset class are also distinct. For instance, equity is known for high risk and return.
Here are some things to know about each asset class:
1. Equity:
Equities include stocks of a company. They reflect your ownership when you buy stocks of a business. For instance, if you buy 50 shares of a company that has a total of 10,000 shares, you will own 0.5% of the business. If the company’s stock price increases, you will profit, and if it decreases, you will incur a loss, just like an owner. You can also earn a return in the form of dividends when the company makes money. Some companies share a part of their profits with shareholders while others reinvest them back into the business.
Stocks are subject to market conditions, and may get risky at times. Demand and supply, as well as other factors like corporate decisions, political upheaval, etc., can impact the sales of a business and, ultimately, its share price. Stock prices can also fluctuate on speculation, brand image, and more. A recent event where international footballer Cristiano Ronaldo moved two bottles of Coca-Cola for a bottle of water lowered the company’s stock price from $56.17 to $55.22, bringing a $4 billion loss in market value for the company.
Stocks are highly volatile, which is why they make for an ideal pick for experienced investors for a long investment term.
2. Debt or fixed-income:
As the name suggests, fixed-income investments are relatively more stable and can offer you a steady income. Unlike equity, where you are the part-owner, you are the lender in the case of debt. When you invest in debt instruments like bonds, you loan money to corporate, government, or municipal institutions. These institutions pay you interest in return. At the end of the investment term, you receive your principal amount along with interest. You can think of this as a loan where you play the role of the bank.
Debt investments can be more stable and low risk, but they offer lower returns compared to equity. They do carry some risks like credit and interest risk, but the risk levels can vary. For example, corporate bonds may hold the most amount of risk out of all bonds. Municipal bonds can present moderate risk. Government bonds may be the least risky out of the three. They can be suitable for an investor with a low-risk appetite. Moreover, they can offer diversification in a well-balanced retirement portfolio.
3. Cash and cash equivalents:
Cash and cash equivalents play a crucial role in balanced asset allocation. This asset class brings in liquidity, so you can easily access your money in the case of an emergency. Cash can be in any currency in your savings bank account. It can also be in highly liquid investments like liquid funds that have short maturity periods of up to 90 days. Cash and cash equivalents are not linked to the market, so they may not offer you a high return. Their main agenda is to provide you with liquidity during an emergency.
4. Real estate and other similar assets:
Real estate can be a stable investment with a high rate of return, usually effective in overturning inflation. It can bring in financial security and allow you to create a secondary source of income through rent, lease, sale, etc. Real estate is also a great family asset and can be owned by more than one person in a family.
Other than real estate, you can also add other tangible assets to create a balanced portfolio, such as gold, collectibles, and more.
Steps to creating a well-balanced portfolio
Now that you know the asset classes and the risk and return they offer, you can create a portfolio easily. There are three types of portfolios:
- Aggressive portfolio: An aggressive portfolio has a high concentration on stocks. The primary goal here is to earn high returns over a long investment term. This can be an ideal well-balanced retirement portfolio for a young investor with several years left to retire.
- Moderate portfolio: A moderate portfolio is generally opted for by middle-aged investors. They have some years to retire but may not be in a position to take a high risk with total equity. So, they build a moderate portfolio that is a mix of stocks, bonds, and cash with a deeper focus on stocks.
- Conservative portfolio: Most retirees or those nearing retirement pick a conservative portfolio as it primarily focuses on capital preservation. A conservative portfolio is concentrated on fixed-income instruments with a small allocation to stocks and the rest on cash and cash equivalents.
You can assess which of these categories you fall into on the basis of your age, income, retirement age, financial obligations, investment budget, and goals.
Once you understand your basic profile, you can use the following tips to build the best investment portfolio for your requirements:
1. Maximize your 401(k):
The most significant benefit of an employer-sponsored retirement plan is the match you can get from your company. Your employer can offer to match your contribution for every dollar you contribute to your plan. This can easily be free money that can secure your future by helping you create a well-balanced retirement portfolio. The contribution limits for a 401(k) are also considerably high. In 2022, you can contribute up to $20,500 per annum. If you are over the age of 50, you can make a catch-up contribution of $6,500 and invest a total of $27,000 in a year. Even if your employer does not match your contribution fully, you can still boost your retirement fund considerably with their match. The Internal Revenue Services (IRS) offers two types of 401(k)s – a Traditional and a Roth. The former is run on your pre-tax dollars and does not tax contributions. Contrarily, the latter accepts after-tax dollars and taxes your contributions. The withdrawals from a Traditional 401(k) are taxed as per the income tax slab you fall in retirement, whereas the withdrawals from a Roth 401(k) are not taxed.
If your employer does not offer a 401(k), you can consider an Individual Retirement Account (IRA). In 2022, you can contribute up to $6,000 or $7,000 if you are over the age of 50. Just like a 401(k), an IRA also offers a Traditional and a Roth account with the same difference in taxes.
2. Diversify your investments:
A well-diversified portfolio is a well-balanced portfolio. The two terms can be used synonymously in investing. Diversification is one of the keys to creating a successful financial strategy. It refers to investing your money into a variety of asset classes to reduce risk. As discussed above, equity carries the highest risk. If you invest only in equity and the stock market falls, you stand to lose all your money. However, if you invest in equity, debt, and real estate, your debt and real estate investments can stabilize your returns, so the performance of equity alone does not affect your portfolio.
You can diversify across asset classes as well as within asset classes. For instance, you can further diversify in different sectors and companies in an aggressive portfolio. This way, you do not rely on a single company to do well. Instead, you put your stakes in multiple companies. You can also diversify as per the market capitalization of companies, such as small, medium, and large. Or you could invest in domestic and international markets. Diversification can be a tricky activity. Under as well as over-diversification can harm you and lead to more risk. So, you can benefit from hiring a financial advisor and getting some professional assistance on the matter.
3. Understand your risk and the fact that it changes with time:
Your ability to take risks will depend on your income, professional competence, age, goals, investment horizon, and more. Understanding your risk appetite can help you devise a balanced asset allocation strategy. It is also essential to know that your risk appetite will change through the years. If you are in the high-income category and in a stable place in your career, you can afford to take on more risks. In such a case, you can focus on the future and save for your long-term goals like retirement, and more. However, if you are struggling to make ends meet and in an unstable job, your primary focus can be to build an emergency fund. This means you would need to focus on cash and cash equivalents to establish a highly liquid asset for yourself that can help you if you lose your job. The risk appetite can differ for each individual based on several factors. So, taking time to evaluate your unique situation can be very helpful.
4. Reduce debt liabilities:
Your portfolio can be affected by your debt liabilities to a large extent. If you have pending loans, you may not have enough funds to invest. High-interest debt like student loans can stall your portfolio’s performance too. Your investment returns should ideally be used to fuel your future goals and not to clear your past expenses. If you end up using your investment returns to clear your debt, you may end up jeopardizing your future. Nevertheless, it can help to prioritize your debt first and clear it as soon as possible. Once all your loans have been paid off, you can pay attention to your future financial concerns. Another thing to keep in mind when clearing debt is to not take on more debt while you are already paying liabilities. This includes credit cards and small personal loans.
5. Rebalance your portfolio:
Your portfolio should also be aligned with your goals. If your goals change, so should your investment portfolio. For instance, if you have been diligently saving for a home purchase, once you purchase your home, you must focus on maximizing your investment returns to be able to pay back your home loan. Likewise, if you were investing for a child’s higher education and have now sent the child to college, you must shift your gaze to retirement completely, which might be the next stop in your investment journey.
Rebalancing your portfolio is also vital as your investments are bound to fluctuate depending on market conditions. If you have a 60 to 40 stock to bonds ratio right now, and your stock investments perform well, your asset allocation may fluctuate to 65 to 35. This means you would now be exposed to a higher level of risk with more stocks than anticipated. If your risk appetite does not allow you to take such liberties, you would have to rebalance your portfolio. Rebalancing is a critical part of the process and something that needs to be done periodically. Financial advisors recommend rebalancing your portfolio every six months to a year.
To summarize
A balanced portfolio is one that reflects your needs the best. It does not have to be the same as your spouse, friends, colleagues, or a famous business person you follow. As long as it aligns with your goals, it can be the best investment portfolio for you. However, it is essential to understand the different asset classes and how they function to be able to create one. Once you know the role each asset and investment class plays in your portfolio, you can go ahead and build a well-diversified portfolio that can offer you capital appreciation and preservation with reduced risk and enhanced returns.
If you are unable to do so or need professional advice on the matter, you can always reach out to a financial advisor in your area who can create a customized strategy for you to build a well-balanced investment portfolio that matches your risk profile, present and future financial goals, and investment horizon.Use Paladin Registry’s free advisor match tool and get matched with 1-3 qualified advisors who may be able to help you with your unique financial goals and requirements.
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