So you’re ready to start investing. That’s great. Putting your money to work with a successful investing strategy is a core component to generating long-term wealth.
What is a portfolio?
You’re going to be building a financial portfolio. But what exactly does it mean to build a portfolio?
Anatomy of a portfolio
What is a financial portfolio? Simply put, it’s a collection of financial assets. It could contain a number of financial products like stocks, bonds, cash and cash equivalents, alternative investments, even life insurance, property or other assets.
In an investment portfolio these are called “asset classes.” You’ll want to have a mix of different asset classes in your investment portfolio to balance the potential for growth and the risk that you’ll lose money. This is an approach known as diversification – holding different types of securities that will perform differently than one another depending on varying market conditions.
Assets in a financial portfolio
Stocks represent ownership interest in a company. You can make money in stocks when the company pays a portion of its profit in dividends or when the value of the company increases, and you can sell your share for more than you paid for it. (Just imagine if you’d bought stock in an internet company 10 years ago.)
Whether you realize it or not, you’re going to be building a financial portfolio. But what is a portfolio?
Stocks are generally a way to grow the amount of money you invest. From 1926 to 2022, Large-Cap stocks enjoyed an average annual return of nearly 10.5 percent.1 But their values can fluctuate pretty widely, making them an investment with higher risk — especially in the short term.
Many people choose an investment portfolio weighted toward stocks. The percentage of your portfolio made up of stocks can depend on your risk tolerance and how far you are from needing the money that you’re investing, often referred to as your time horizon.
Bonds are investments in debt. Bond investors loan money to bond issuers, typically a corporation or government. The terms of the bond establish when the bond matures (when it will be exchanged for cash) and the interest that it will accrue and pay. Though you can purchase bonds directly from an issuer, bonds can also be bought and sold on exchanges much the same way that stocks are traded.
Bonds are typically considered less risky types of investments compared to stocks. In other words their values do not fluctuate as much as stock prices . As a consequence, bonds usually do not provide the same return potential as stocks.
Cash and cash equivalents are more or less exactly what they sound like. They are a portion of a portfolio consisting of cash (which can be both domestic and foreign currency) as well as any other investment that can be easily converted into cash such as certificates of deposit, money market funds and short-term government bonds.
Cash and cash equivalents typically return little profit in a portfolio, but they are an important component of any portfolio nonetheless. In addition to covering emergencies, having cash on hand allows you to make an investment in a timely manner should an opportunity present itself.
Funds are in some ways portfolios themselves. Funds collect money from individual investors and then invest based on the fund’s design. A mutual fund, for instance, may invest in certain types of stocks, bonds or other investments — perhaps in a certain region of the world. An exchange-traded fund (ETF) is designed to have very similar performance to a certain index, like the S&P 500 or NASDAQ.
Funds may be a good way to gain exposure to different kinds of investments in your portfolio without having to buy all the individual securities yourself.
Risk tolerance and your financial portfolio
Ultimately, what you put in a portfolio depends on your tolerance for risk. If you invest heavily in stocks, you may make more in the long run than someone who just invests in bonds. But in the short term, you could also lose more. When constructing a portfolio, you’ll want to think through how much risk you’re willing to take.
If you're looking to take your portfolio to the next level, it can be a good idea to connect with a financial advisor who can customize your financial portfolio to your goals and level of risk tolerance.
1 Morningstar Direct.
All investments carry some level of risk including the potential loss of principal invested. Diversification and strategic asset allocation do not assure profit or protect against loss. Stocks/Equities have greater potential for gains as well as greater potential for loss than bonds/fixed income investments. Performance shown represents past performance and is no guarantee of future results.
Exchange traded funds (ETFs) have risks and trade similar to stocks. Shares of ETFs are bought and sold in the market at a market price, as a result, they may trade at a premium or discount to the fund's actual net asset value. Investors selling ETF shares in the market may lose money including the original amount invested.
You should carefully consider risks with fixed income securities such as bonds, these include: Interest rate, Duration, Credit, Default, Liquidity and Inflation. Interest rates and bond prices tend to move in opposite directions, for example when interest rates fall, bond prices typically rise. This also holds true for bond mutual funds. A low interest rate environment may cause losses to bond prices and bond funds you own or in the market. High yield (Junk) bonds and bond funds that invest in high yield bonds present greater credit risk than investment grade bonds.