How to Build an Investment Portfolio
There are many factors to investing that are either not understood or intimidating for some people, delaying them from building a portfolio for themselves. Everyone says “start investing as soon as you can” but where do you start? Your investment portfolio contains all assets you own, such as stocks, bonds, mutual funds, etc. in order to understand how to build one, think of your investment portfolio as an umbrella term for your investments for the following types of accounts:
- Individual retirement account
- Self-directed, taxable brokerage account
- Cash held in savings accounts
- 401(k) or another employer-sponsored plan
The following 4 steps will determine how you should build your investment portfolio, in order to arrange your assets to prepare you for achieving your long-term goals.
Determine Your Target Asset Allocation
Before you start investing, you want to determine what your long-term goals are. These goals will guide you to the right asset allocation. There are four factors to asset allocation:
- How much your goal will cost
- How long you have to reach it
- How much you’re saving toward it
- Your risk tolerance
For younger investors, it’s recommended your portfolio is more aggressive as there is more time to reach your goals. If you have credit card debt or student loans, it makes more sense to focus on paying off those payments first. The more you save toward your long-term goals in the meantime means not having to rely on your investments to provide enough returns to reach those goals.
Start Investing in Your 401(k)
Once you’ve determined how you want to invest, you can start building your portfolio. You’ll want to refer back to your target asset allocation when picking your investments for your 401(k), a good start for investors is to have quality mutual funds- one for investing equities and another focused on fixed income. To make things easier, you can use target-date funds, which are mutual funds that adjust allocation over time, aligning with the date of your projected retirement. Asset allocation funds are similar in that they maintain a fixed allocation. Remember with both of these if your goals or time frame change, so should the fund, so remember to still keep these in check.
Opening an Individual Investment Account
Outside of your 401(k) there are many investment options. An individual investment account can pertain to any of your goals, such as retirement, buying a house, or stock. Setting up other individual investment accounts are important in order to distribute your assets, and provides diversification which we’ll address next. Remember to refer back to your original goals and target asset allocation when determining what you want to do with your investments.
Spreading out your money can aid in ensuring your portfolio isn’t too dependent on any particular asset. Stocks and bonds are typically the different assets people invest in, and how much money you allocate to each is dependent on age. The common recommendation is to subtract your age from 100 to decide how your portfolio should be invested. For a 30-year old, it would be recommended that 70-80% of their portfolio be allocated to stocks, and 20-30% to bonds.
Low-cost index funds (mutual funds or ETFs) are recommended for tracking the diversification of your portfolio. These funds track broad indexes such as S&P 500, and is an easy way to achieve diversification in a way that’s affordable for you. Remember your investment portfolio is to help you plan for your long-term goals, so if the world of stocks aren’t for you, there are other options for investments that can get you on the right track to achieving your goals.