How to Create a Good Investment Portfolio

Looking forward to investing wisely for the future? Here are some useful tips on how to create a good investment portfolio that will see you through the ups and downs in the economy.

 

Investing for the future is not only essential but also is something that you should start early. When we think of investing, what comes to our mind is the stock market. However, you'd be surprised to know that there are several other areas of investment and it is up to you to decide the ones that are best for you. So, which is the best way to invest, you may ask. Well, the truth is that there are several factors that you need to consider before you arrive upon a decision as to where you should invest your hard-earned money. A common trick is to have a diversified investment portfolio by investing in a variety of investment vehicles. This reduces the level of risk to a great extent. So, what to go for and what to avoid while creating your investment portfolio? Just go through this article to find out for yourself!

How to Build the Right Investment Portfolio

Set a Goal for Investment
The first step towards creating a good investment portfolio is to set a goal for yourself. What do you want to invest for? How much money would you need and after how long? Once you have found answers to these questions, chalk out your investment plans accordingly. Remember that how you invest shall depend a lot on what you're investing for. For example, if you are investing for a new home, you would naturally want the returns soon. On the other hand, if you are planning to invest for a comfortable life post retirement, then you'd definitely want something that helps your money grow considerably over a prolonged time (provided you start investing early in your career). Also, the amount of money that you would need is something that you should calculate beforehand. This would play a key role in helping you choose what you would invest in.

Invest for Emergency
So, you have set your long-term and short-term goals and are prepared to chalk out an investment plan. But wait! What about emergency situations that may arise? Would you be financially ready to face them? For this, you need to invest some amount of money in cash equivalent investments such as investing in gold and precious metals, liquid funds, savings accounts and treasury bills. In addition to this, you need to invest in insurance plans to protect yourself and your family in the face of an emergency.

Calculate the Risk Involved
Let's consider that you have zeroed in on an investment vehicle that is likely to fetch you high returns. But are you willing to take the risk that comes with it? It's human nature to aim for the highest possible returns on the money invested. But remember that high returns are accompanied by higher risks. In fact, higher the risk you are willing to take, higher the returns you get! So, is it a wise decision to put your money at stake just for the sake of higher returns? Definitely not! You should decide what level of risk you can handle and you should do this after taking into account factors such as your age and experience. Remember that putting your money in the stock market involves risks such as market risk (the entire stock market experiences a decline), industry risk (stocks of a particular industry, such as the steel industry, experiences a decline), and individual stock risk (decline in prices of stocks of a particular firm or organization).

Create a Diverse Portfolio
Creating a diverse portfolio means that you should invest in a variety of investment vehicles. This way, you invest your money in both low-risk as well as high-risk vehicles, and your risk gets balanced out. You can invest in bonds, stocks, mutual funds, cash equivalents and even property. A good way to balance your investment portfolio is to invest in stocks, bonds and mutual funds.

Stocks: Stocks are nothing but shares in the ownership of a firm. When you buy stocks of a company, you should know that the value of the stocks is directly proportional to the profits earned by the company. In other words, the more profit a company earns, the higher the value of its stocks. Stockholders earn a percentage of the company's profits, depending on the value of the stock purchased by them. The higher the profits made by the company, the higher the returns you earn from stocks. However, in case the company suffers losses, you don't stand to gain any returns. Not only this, the price of the stocks of the particular company also falls, due to which it becomes difficult for you to recover your initial investment by selling the stocks you hold. So, you see that stocks are quite risky and hence it is not recommended that you invest your entire investing amount in purchasing stocks.

Even though it is difficult to predict the future growth of a company, the P/E ratio can help you to some extent in this regard. Before investing in stocks of a company, you can determine whether there is any probability of the stock prices going higher due to substantial growth of the company or huge profits. The P/E ratio or price-to-earnings ratio is the ratio of the price paid for each share to the amount earned per share by the company. Let's consider an example: say a company earns $3 per share while each share sells in the market for $30, then the P/E ratio is 10 (30/3=10). The higher the P/E ratio of a particular company, higher the demand for its shares in the market.

There are two basic types of stocks: blue chip stocks and small cap stocks.

• "Blue chip" stocks refer to the stocks of big and established companies that have had a consistent record of earning profits and paying dividends to their stockholders on time.
• "Small cap" or small capitalization stocks refer to stocks of newly established or less established companies.

The interesting thing about "small cap" stocks is that they have the potential to give big returns if the company witnesses immense growth. However, there is also a greater chance of depreciation in the value of "small cap" stocks, and this can happen when the company fails to witness growth as anticipated.

Bonds: Bonds are different from stocks because they offer a fixed income for a certain interval of time and a bondholder does not have a share in the ownership of the company. Bonds are issued for the purpose of collecting capital from investors who are ready to invest in a new venture. A bond signifies that the company has borrowed a certain sum of money (the price paid for the bond) from the person who purchased the bond. It is a promissory note which states that the company is liable to return the principal amount paid for the bond, along with a fixed return. This "fixed return" is nothing but the interest on the principal amount paid for the bond, and is determined by the rate of interest mentioned on the bond. This rate of interest is termed as the coupon rate. The advantage of bonds is that you earn a fixed amount, irrespective of the revenue earned by the company. Every bond has a predetermined time period (known as the time to maturity of the bond) after which the bondholder gets back the principal amount from the company. Depending on the market condition, an investor should decide whether he should invest more of his money in bonds or in stocks.

Mutual Funds: A mutual fund is a low-risk, fixed-income investment. A professional creates a portfolio consisting of stocks and bonds, and units of this portfolio are then sold to individual investors. To invest in a mutual fund, all you need to do is just purchase a small part of it. The advantage of investing in mutual funds is that the risk involved is negligible, and you have a range of mutual funds to choose from. Moreover, mutual funds are relatively hassle-free as they do not require you to keep a tab on the market trends. This is because the professional manager who assembles the mutual fund, takes care of this.

Practice Asset Allocation
Now that you know about the benefits of diversifying your profile, it is also important to allocate the correct amount of money under each area of investment. This is known as asset allocation. The general rule is to invest more in low-risk vehicles and less in investments that come with a high level of risk. If you are investing in both, bonds and stocks, the ratio between the two should ideally be 80-20. What you should aim for, while creating your investment portfolio, is that it should protect you from changes in the economy. In other words, even if the market witnesses decline, there should not be a drastic change in your returns. A good idea would be to get a financial checkup done to chalk out a design for your investment portfolio, taking into consideration your goals and willingness to take risks. Your bank will help you in this regard.

Invest Wisely
No matter where you invest your money, it pays to invest wisely. Be logical at every step, and think twice before you invest, to save yourself from losing your money. Hurrying with investment decisions is not advisable, as experts say that you should research well before you decide to invest. If you're investing in the stock market, you should observe and study the market trends carefully to know where exactly you should invest and how much. Certain investment vehicles promise to fetch you very good returns in a short period of time, but they are risky. Even though you can set aside a small amount to invest in high-risk investment vehicles, it is best advised that you refrain from taking huge risks when it comes to your investment. It is for a simple reason: one bad decision, and you end up losing a lot! Just look at it this way: you may gain many times the amount you invest in high-risk investment vehicles, but there are good chances that you may have to part with the entire sum of money! On the other hand, if you invest in simple investments that involve little or no risk, you are sure to get a considerable amount at the time of your retirement, or whenever you want to.

Tips for Creating an Investment Portfolio

Now that we have learned how to invest, here are some tips that will take you a few steps closer to that perfect investment portfolio.

• While you can always do your own research before investing, hiring a professional financial advisor, can make things easier for you.
• Investing your money isn't just a one-time job. As market trends keep changing every other day, it is essential that you evaluate your investment portfolio regularly.
• Your investment portfolio should have sufficient liquidity, which means at least a part of your investments should be such that you can sell them easily to get cash.
• Don't forget to invest in accounts that are exempted from tax. Investing in plans such as 401k retirement benefit plan, individual retirement accounts (IRAs), municipal bonds, etc., is a wise investment decision because these are investments with double benefits. Not only do they make your money grow, but they also reduce the amount you pay as taxes.
• While calculating the amount you can invest, make sure you take into account any debts that you have, such as pending credit card payments or loans.

You should aim for an investment strategy that helps your wealth grow steadily, so that by the time you retire, you would have enough to sustain your lifestyle and live comfortably. The trick is to begin investing wisely from an early age and to set realistic goals. While investing in a few short-term investment vehicles is fine, you should focus more on the long-term benefits of your investments. Even after retirement, you can keep on investing and watch your money grow.

By Mukulika Mukherjee