Having an investment portfolio is one of the best things you can do for your future as well as your mental wellbeing.
Nothing is more stressful than losing your income from your job or business and not having a financial safety net to fall back on.
Worse still, is retiring and not having enough to live a normal and dignified life.
Not only does an investment portfolio protect you during the hard times, but it can also provide you with a safety net so that you can quit your job to move in a new direction.
For some astute investors, it could also mean complete and utter financial freedom so that they never have to work another day of their lives.
With so much of your personal freedom and wellbeing riding on your investment portfolio, it is important that you build it correctly so that it can meet your needs.
Unfortunately, many would-be investors jump straight into the markets and quickly get burned, rather than educating themselves on important topics like portfolio construction and risk management.
This article will provide a step-by-step guide to the steps you need to take to build an investment portfolio.
Contents
- Decide How Much You Can Set Aside On A Regular Basis
- Determine Your Investment Objective
- Choose Your Timeframe
- Identify Your Personal Risk Profile
- Select Your Asset Allocation
- Establish Your Brokerage Account
- Set Up An Automated Bank Transfer
- Begin Investing
- Conclusion
Decide How Much You Can Set Aside On A Regular Basis
There’s an old, but well-respected rule in wealth building called “pay yourself first”.
Unfortunately, most people actually “pay themselves last” – their hard-earned money goes towards bills and purchases first and then whatever is left over is saved.
You have to flip this thinking on itself, such that you always pay yourself first.
You need to make a commitment to your financial future and commit to setting aside a regular amount of money from each and every paycheck you receive.
The amount you should set aside is up to you, but most wealth generation experts agree that the minimum should be at least 10% of your income.
Determine Your Investment Objective
Often overlooked, understanding your personal objective investment is paramount – it sets the scene for so many aspects of investing, including portfolio construction, risk management, and investment time horizon.
First, start by asking yourself why you want to create an investment portfolio in the first place?
Some common reasons might be:
- To provide for my family in retirement
- To have enough money to go on a holiday regularly
- To buy a house
- To reach financial freedom
- To have enough to switch careers or start a business
- More income for a better lifestyle
Regardless of the objective, the next step is to identify what success looks like.
To do this, get specific on just how much you need to have in your portfolio (this can be on an asset/income basis or even both).
For example, you might have a goal to live comfortably in retirement, which for you means $60,000 a year – therefore success will be an investment portfolio that generates $60k annually.
Choose Your Timeframe
Now that you know what dollar amount you are going for, the next step is to pick your investment timeframe.
This step will influence what assets you might choose to invest in, as some perform better over shorter timeframes while others benefit from exposure over decades.
Whatever your objective is in step 2, work out when you would like to achieve it by and then count back to today’s date.
Identify Your Personal Risk Profile
Understanding your personal risk profile is probably the most vital step in the entire process.
The reason being is that you can do all the right things, from saving diligently, picking the right assets, and making regular investments, but you could undo all your hard work with one ill-timed, emotion-based decision.
For example, if you started investing in 2007, you would have seen your stocks savaged by 54% during the Global Financial Crisis of 2008.
Many investors sold during this time, locking in losses.
However, if they had held on they would have enjoyed an annualized 10-year return of 7.8% on their initial investment in 2007.
That’s why understanding your personal risk profile is so important – when the next market crash happens you don’t want to be selling due to fear.
Generally speaking there are three main types of risk profiles:
- Aggressive
- Balanced
- Conservative
If you’re the sort of person that hates the thought of losing even a single dollar, then you’d be a conservative, while aggressive risk profiles suit those that are willing to take large swings in the short term for potentially larger gains over the longer term.
It’s important to note that no single risk profile is better than the other – the best risk profile is the one that matches your actual risk tolerance.
There’s no use picking aggressive or balanced, with the hope of making high returns, if a small decline of 5% of your portfolio balance leaves you anxious and unable to sleep.
Be honest and truthful with yourself, particularly looking at patterns of behavior when you had to take a lot of risk and more-so, how you behaved when surrounded by, or in the grip of, fear and panic.
Select Your Asset Allocation
Proper asset allocation is a whole topic unto itself, but there are some general principles you should follow.
There are two aspects to asset allocation.
The first is to determine which assets you will use while the second, is to determine how you will manage your asset allocation.
When choosing the assets you will use in your portfolio, you will be balancing two factors – your risk profile and investment timeframe.
In general, as risk increases, so too does reward.
However, there is a time component as well, in that your risk can increase in the short term without a corresponding increase in reward – so selecting the right asset mix is critical.
For example, stocks are one of the most popular asset classes.
Over the last hundred years, they’ve returned on average 10% a year.
However, in any given year you can have price swings of +30% to -60% or more.
If you are a conservative investor looking to build an investment portfolio to buy a house in the next 3 years, stocks would be a bad choice.
Here are some of the asset classes you might consider depending on your risk profile:
- Conservative: Cash (e.g. term deposits), bonds and treasuries.
- Balanced: As per ‘Conservative’, but also add stocks and property.
- Aggressive: Leveraged investments, derivatives, stocks, and property.
For shorter timeframes, cash, bonds, and treasuries are your best bet as they are unlikely to lose any capital.
In terms of how much to buy of each asset class, two of the most popular portfolios are the 60%/40% equities to bonds split and Ray Dalio’s ‘All-Weather’ portfolio.
Establish Your Brokerage Account
Once you’re ready to begin investing the next step is to sign up with a broker who will buy and sell the assets on your behalf.
I use Interactive Brokers and am really happy with them.
Generally speaking, there are two types – full service and brokerage only.
Full-service brokers are useful if you’re looking for value-add activities like personal advice, research reports, and recommendations.
Otherwise, for most people, a brokerage only account is enough.
Set Up An Automated Bank Transfer
To help you stick to your investment plan, set up an automatic direct debit of your monthly investment amount from step 1.
This way as soon as your paycheck comes in, the money goes straight towards your investment portfolio so that you don’t get tempted to spend it all.
Begin Investing
With all that in place, you can start investing – contact your broker and place your first trade.
If you’re starting with a large lump sum, it’s generally a good idea not to invest all your money in one go, as you could be buying at the very top of a market.
Spread out your purchases over a number of months which means that you’ll have a combination of both low and high prices and you don’t get caught out by any impending market falls.
Over time, your investment objectives may change or your portfolio may become unbalanced as some assets perform better than others.
Regularly monitor your portfolio to ensure it is meeting your investment objectives, rebalancing your asset mix at least once a quarter, if not once a month.
Conclusion
Setting up an investment portfolio is an important step in securing your financial future and peace of mind.
Done properly, it can enable you to achieve your long term aspirations and provide you security to take on bigger risks or to live comfortably now and into retirement.
While there are a lot of considerations for portfolio composition and strategy, the broad steps to get started in building an investment portfolio are:
- Decide how much you can set aside on a regular basis
- Determine your investment objective
- Choose your timeframe
- Identify your personal risk profile
- Select your asset allocation
- Establish your brokerage account
- Set up an automated bank transfer
- Begin investing
Always ensure you exercise appropriate risk management strategies and stick to your long term plan so you can let compound growth do all the heavy lifting for you.
Trade safe!
Disclaimer: The information above is for educational purposes only and should not be treated as investment advice. The strategy presented would not be suitable for investors who are not familiar with exchange traded options. Any readers interested in this strategy should do their own research and seek advice from a licensed financial adviser.
