Successful investment formula lies in the right balance of risk and profitability for the investor. Creation of an investment portfolio is focused on achieving this balance, and this is its main task. The presence of an investment portfolio protects the investor from emotional and unreasonable decisions, allows to achieve financial goals with an adequate level of risk, to monitor the success of individual assets and to keep within the set time horizon. Most often, an investment portfolio is a combination of financial (gold, stocks, bonds, ETF funds, cash) and non-financial (real estate, art and other physical assets) assets in different proportions, which depends on the investor’s goal. Of course, there are many models of investment portfolios and techniques for choosing percentages in its composition, and perhaps we will discuss them in detail another time, but today we want to tell you about the main points that should be considered in creating of any investment portfolio.
First of all, it is important to realize that there are no universal schemes for creating a succesful investment portfolio suitable for each investor. This is an individual process, which depends on the goals of a particular investor and his or her capabilities. And by capabilities we mean not only the amount of capital (nowadays it is possible to invest from a few thousand crowns), but also the time for which the investor is ready to invest his money, as well as his age, experience and level of expertise in investing. Therefore, the initial task is to decide on the goal of your investment portfolio. For example, this goal may be: protecting capital, creating passive income, accumulating a mortgage down payment or a large purchase, multiplying capital, etc. A specific goal is necessary for you to build a plan for its achievement, as well as clearly see at what stage from it you are and what to change in your investment strategy, in order not to go wrong. Also, by defining your goal and selecting the appropriate investment portfolio you will save yourself from the emotional factor and making unreasonable decisions. In addition, before assembling an investment portfolio, it is important to understand what level of risk is acceptable to you, as well as the time horizon, i.e. how long you plan to own investment assets. This is important in order to properly allocate assets in the appropriate percentages and to determine an investment strategy. For example, an investor whose goal is to preserve capital will be less risk-tolerant and a conservative investment portfolio model will work best for him, while an investor whose goal is higher income is willing to take more risks and an aggressive portfolio model (which includes mostly more volatile and risky instruments, such as startups or cryptocurrency) will work best for him. This does not mean that a conservative investor collects only real estate as assets, he may invest in cryptocurrency, but it’s all about the percentage of instruments in the investment portfolio.
So, after defining the above parameters, we can already plan the share of each instrument in the investment portfolio. Most often assets are allocated about 40-60% to some “main” instrument, which is determined by the goal of the investment portfolio (for example, for a conservative investor it can be ETF funds, government bonds, real estate), and the remaining instruments can be more risky (stocks, start-up companies with prospects for growth, cryptocurrency and so on). The investment portfolio model is selected individually, as we mentioned above. Once the assets are selected and purchased, the investment portfolio is assembled – we can go on a financial journey.
Yes, creating an investment portfolio is not a one-time purchase of assets for holding, but a continuous process that lasts the whole time of its existence. Just by defining the goals and its components correctly at the beginning, we form the principles that will help us make the right investment decisions at the next stages: rebalancing and the evaluation of results. This saves you nerves and reduces the risks of investing.
The market is constantly moving, every day the behavior of instruments is affected by many factors, and for this reason, it is a necessity for every portfolio owner to review the proportion of assets in the portfolio, to rebalance it. Even the investment strategy of the outstanding scientist Alfred Nobel had to be reviewed and adjusted over time in order for it to continue working for the benefit of the Nobel fund (we wrote about it in Instagram, if you are interested – the link to it is at the bottom of this page), so it is important to do it regularly. With what frequency – will depend on the type of investment portfolio and strategy. The rebalancing phase involves reviewing the assets with the largest increases or decreases in value that affect the overall balance of the portfolio. The purpose of rebalancing is to return to the initial proportions according to which the instruments in the portfolio were selected, i.e. it is likely that something will have to be sold, something on the contrary will have to be added in order to keep the percentage ratio and continue moving towards the financial goal. Part of rebalancing is also monitoring and evaluating the efficiency of portfolio management. Certain techniques are used for this purpose. The simplest method is the method of calculating the absolute return on investment. That is, the difference between the buy and sell price of how much the portfolio as a whole has earned over the entire period of existence. This method is suitable for short-term and medium-term investment portfolios, but for long-term portfolios it is not informative enough, because this method does not take into account risk and inflation. Another method is the assessment of relative profitability, which is the absolute profitability in comparison with an instrument – a guide, a benchmark. Most often these are stock indices such as the S&P 500. Here you compare the indicators of the asset in your portfolio (its yield) and the yield of the benchmark, on the basis of the difference in indicators you can assess the effectiveness of investment. More complex methods, using investment formulas, are used when calculating risk-adjusted returns – when you need to evaluate the effectiveness of the investment taking into account possible losses. It is always better to use several methods at once to evaluate the performance of your investment portfolio, this will have a positive impact on the quality of your investment decisions and investment outcome.
All the above certainly requires inclusion on the part of the owner of the investment portfolio, to do it professionally you will need to invest a sufficient amount of time and effort in your knowledge and constantly replenish it. But you can also move away from the strategy of active management and hand over the management of your investment portfolio to specialists who can do this work for you. Nevertheless, you should know how to compile an investment portfolio and what indicators to take into account, if only to be able to evaluate the effectiveness of the investment manager to whom you entrust your assets. Develop your investment mindset, consult with professionals, study the market and assets from different angles. This will help you achieve your financial goals in a comfortable pace and take into account the maximum possible number of factors that influence the result of investing.