If you own any financial assets, you have a portfolio, whether you realize it or not. A portfolio is the combination of all the assets you own. Financial assets such as stocks, bonds, and cash are all part of your investment portfolio, but it also can include other assets, like real estate.
Understanding what constitutes a portfolio will help you manage and build your own.
What Is a Portfolio?
A portfolio is a broad term that can encompass any financial asset, including real estate or collectibles, but people generally use it to refer to the total of someone’s income-earning assets. An investor’s portfolio, also known as their holdings, can include any combination of stocks, bonds, cash and cash equivalents, commodities, and more.
Some people and organizations manage their own investment portfolios, while many choose to hire a financial advisor or other financial professional to manage portfolios on their behalf.
How an Investment Portfolio Works
An investment portfolio can help you grow your wealth to achieve future financial goals such as an adequate retirement fund. The basic premise is that you purchase investments, which increase in value, and thereby, you earn money.
The different types, or categories, of investments you choose for your portfolio is referred to as "asset allocation." Assets generally fall into three main classes: equities (stocks), fixed income (bonds), and cash and cash equivalents (savings and money market accounts). Within each general category, you have a number of choices. For instance, equities include individual stocks, exchange-traded funds (ETFs), and managed mutual funds.
To avoid being overly exposed to losses within a single company or industry, investors also often choose to diversify their portfolios among a number of investments across asset classes.
Types of Portfolios
You already may have an investment portfolio in the form of a retirement account through your employer. Others may have portfolios in which they actively buy and sell assets with the goal of making a short-term profit. Some people invest for midterm goals, such as buying a home. Some have multiple portfolios designed to accomplish a range of goals.
There are a handful of different types of investment portfolios. Each type generally corresponds to a specific investment goal or strategy, and comfort with risk.
A growth portfolio, also known as an aggressive portfolio, involves taking on a greater level of financial risk for the potential of a greater return. Many growth investors seek out newer companies that need capital and have room to grow, rather than older and more stable companies with proven track records (and less room to grow).
Investors in growth portfolios are willing to handle short-term fluctuations in the underlying value of their holdings for the potential for long-term capital gain. This type of portfolio is ideal for someone with a high risk tolerance or someone investing long-term.
An income portfolio is built with a focus on creating recurring passive income. Rather than seeking out investments that might result in the greatest long-term capital gain, investors look for investments that pay regular dividends with low risk to the underlying assets earning those dividends. This type of portfolio is ideal for risk-averse investors with a short to medium time horizon.
A value portfolio is made of up value stocks, or stocks that are underpriced compared with the company’s overall financial picture. Value investors buy those underpriced stocks, then hold them as the price increases.
Rather than focusing on income-generating stocks, investors with a value portfolio buy stocks to hold them for an extended period with the goal of long-term growth. This type of portfolio is ideal for investors with a moderate risk tolerance and with a long time horizon.
A defensive stock is one with relatively low volatility in an industry that doesn’t fluctuate heavily with the market. In other words, defensive stocks represent those companies whose products are always in demand, no matter the state of the economy.
A defensive portfolio is made up of low-volatility stocks and is intended to limit losses in a market downturn. Defensive portfolios often have lower risk and lower potential rewards. These portfolios work well for long time horizons, because they lead to smaller but sustained growth.
A balanced portfolio is one of the most common options investors use. The purpose of this type of portfolio is to reduce volatility. It generally contains income-generating, moderate-growth stocks, as well a large percentage of bonds. The mix of stocks and bonds helps the investor reduce risk no matter which direction the market is moving. This type of portfolio is ideal for someone with a low to moderate risk tolerance and a mid- to long-range time horizon.
You don’t necessarily need to choose just one of these portfolio strategies. A well-diversified portfolio can include a mix of growth, dividend, value, and defensive stocks.
Do I Need an Investment Portfolio?
If you don’t currently have an investment portfolio, you might find yourself wondering if you actually need one. After all, isn’t the stock market risky?
A 2020 Gallup poll found that only 55% of Americans report owning stock, a percentage that has remained roughly the same for the past decade. A similar survey by GOBankingRates one year earlier found that the majority of people who choose not to invest think they don’t have enough money to do so.
People put off building a portfolio for many reasons, including perceived risk, the learning curve that comes with investing, and feeling that they don’t have enough money. While these concerns are valid, starting your investment portfolio is one of the best ways to grow your wealth and reach major financial goals and milestones, especially a secure retirement.
A significant number of people who don’t invest point to a lack of trust in the stock market or the fear of losing money. But the stock market has actually seen an average historical return of about 10% annually.
Investment Portfolio vs. Savings Account
People often use the terms “saving” and “investing” interchangeably. For example, we talk about saving for retirement in a 401(k), when we really mean investing for retirement.
And while your savings account is technically a part of your overall portfolio, investing and saving are two entirely different strategies.
|Done in a brokerage account||Done in a bank or credit union account|
|Some risk of financial loss||Risk-free as long as the bank is FDIC-insured|
|Higher potential return||Little to no potential return|
|Best for long time horizons for 3-5 years or longer||Best for short time horizons|
|Protection against inflation||Little protection against inflation|
Low-risk holdings like savings accounts are a critical part of a well-diversified portfolio.
How To Build a Portfolio
1. Decide How You’ll Manage Your Portfolio
For some people, not fully understanding investing is what prevents them from getting started. But for those who don’t feel comfortable managing their own portfolio, there are other options. One of the first decisions you’ll make when building your portfolio is how you want to manage it. A few options include:
- DIY portfolio management
- Using a robo advisor
- Hiring a financial advisor or money manager
2. Consider Your Time Horizon
Your time horizon is the amount of time before you expect to need the money you’re investing. If you’re investing for a retirement that’s roughly 30 years away, your time horizon is 30 years. Experts generally recommend reducing your portfolio’s risk as your time horizon shrinks.
For example, if you’re in your 20s and saving for retirement, you might have a growth portfolio consisting primarily of stocks. But as you near retirement age, you could adjust your portfolio to contain more low-risk investments, such as government bonds. Once in retirement, you might opt for an income portfolio to preserve capital while creating income.
3. Identify Your Risk Tolerance
Everyone has a different appetite for risk. Some people might find the risk of investing exciting, while others want the security of knowing their money will be there when they need it. Your risk tolerance has a major impact on how you choose to build your portfolio.
A more risk-averse investor might choose to stick with investments such as bonds and index funds. However, someone with a higher risk tolerance might explore real estate, individual stocks, and small-capitalization mutual funds.
4. Focus on Diversification
Diversifying your portfolio is an effective way of minimizing losses so that if one investment performs poorly, it doesn’t impact your entire portfolio. You can diversify both between and within asset categories. For example, you could divide your money among stocks, bonds, real estate, and commodities—across asset categories.
But you could also diversify within a specific asset class; rather than purchasing stock from just one company or within one industry, you could invest in an index fund that invests in stocks across industries to achieve a healthy mix.
5. Rebalance as Needed
Rebalancing is when you adjust your holdings to get back to your original asset allocation. Some of your investments will grow faster than others, meaning they’ll begin to take up a larger percentage of your portfolio. To maintain your desired asset allocation, you may need to sell some assets (those in which you’ve experienced growth) and buy more of other types of assets (those that haven’t experienced the same level of growth or have decreased in value).
- A portfolio is the combined collection of an investor’s assets, and can include stocks, bonds, real estate, cash and cash equivalents, commodities, and more.
- People often use their investment portfolios to grow or preserve wealth.
- An investor can manage their own portfolio or pay someone to manage it on their behalf.
- Investors should consider factors such as time horizon, risk tolerance, and diversification when building their portfolios.