Portfolio Investment is the science and art of building a combination of assets to achieve a required rate of return over a period of time. It entails buying and selling securities such as stocks, bonds, ETFs, real estate, bullion, and cryptocurrencies (which are also now an asset class).
Defining Portfolio Investment
Portfolio investment is the bouquet of securities one buys and holds to attain a rate of returns over a period of time. There can be two ways to participate in the growth and returns of a company. You can buy part of a company’s stock and then become the company’s management or buy stocks or bonds of a company and receive dividends, interest, and capital appreciation. The second approach is called Portfolio Investment. Here is a person looking to build financial assets. You will view your Purchasing capacity and Risk bearing capacity before making investments or “buying” a certain number of each asset.
Factors Affecting Portfolio Investment
There are various factors that will affect your decisions regarding portfolio investment.
Age is a decisive factor as it will define your financial priorities and goals. This will further define the characteristics of the kind of assets you will purchase. For a younger person, assets which can give long-term returns will be preferable as he has that many years left, whereas, for an older person, assets with income features will be most helpful. Most assets such as equities and bonds can be defined as per the age requirement in the form of mutual funds.
Risk tolerance is a very important factor as it will determine if and how much you can invest in risk assets. Most assets that give high returns are also high risks. This creates a need to assess how much of a loss can you bear on an asset. If your capital gets wiped out, it should not affect your financial stability and wealth status. That is how you will get started on understanding your risk appetite.
- Usually, it is found that older people, lower-income group people will have lower risk appetite as the earning power is less,
- There can be exceptions to the above rule when the person has savings earmarked for investment or inheritance allows the person to invest in more risky assets.
- People with a longer working age left should look at equities as it will give a long-term benefit of accumulation, and the number of economic cycles will provide more benefit to capital appreciation.
This aspect is related to fulfilling specific financial goals and how much time is left for their fulfillment. If a goal has to say 3 years left to arrive, it makes sense to put the capital in bonds or income funds to ensure capital safety. 3 years might be a short period to earn a substantial return from the equity market. But one might be able to find a diversified mutual fund that can sustain the capital in a good market and give good returns.
Portfolio Investment Strategy
Most of us understand that a portfolio should contain all types of assets – i.e., it should not be concentrated on a specific type of asset – It should be diversified. This will reduce the risks associated with each type of security and increase the overall returns on the portfolio. There are various strategies for portfolio construction and investment.
This kind of portfolio is most suited for people with high-risk appetites as it will include mostly stocks. Stocks are “sensitive” to changes in market indicators – such as inflation, sentiment, and macroeconomic data, which have the potential to change the profit or loss scenario of that company. Thus, under this, while high returns can be expected due to the company’s growth story, or new expansions, it might also be susceptible to setbacks. Managing risk under such a portfolio is of paramount importance, so various risk strategies – hedging, shorting, and cutting losses after appoint should be considered.
Certain stocks provide regular dividends and stable earnings irrespective of the state of the market. These companies have a steady flow of revenues and profits and believe in rewarding their shareholders. They are companies of products that are stapled in nature, and their sale is mostly stable throughout the year. Its nature is to appreciate in share price less than the normal market when the company is expanding. Such stocks provide stability to the portfolio.
This is actually the most commonly used type of portfolio. It entails having a healthy mix of assets – equity, bonds, ETFs, bullion, and others. Each asset has a certain percentage in a proportion that the returns are maximized. The portfolio is checked and re-adjusted according to the changes in the underlying factors of the assets. The idea is to have a healthy mix of assets so that there is no exposure to the specific type of market event, cycle, or issues due to market economic cycles. The downs in one asset will be compensated positively by another asset, and this creates a balance and safety of capital.
Read the concept of Value Additivity to learn more.
Passive or Active Portfolios
The other types of portfolios are by the style of management of the portfolios. Active and Passive are the 2 styles.
Before creating a portfolio, the most important aspect is to also look at the costs of acquiring and selling the assets. The assets sometimes can be more expensive in transaction costs while not giving much return. (real estate). Thus again, risk appetite is a good benchmark.