How To Create A Balanced Portfolio That Brings Profits | A Beginner Step By Step Guide
Stocks, Bonds, ETFs, Crytpo, Real estate, the investment options are plenty. And that's the problem too. If you could equally divide your money between these options and still make profits, it would have been simple. But that's not the way how it works. When you randomly invest your money, you risk putting too much money into a riskier investment and losing all of it or putting too little into an investment that can make you more money. You need to create a balanced portfolio that is personalized based on your financial situation. And that's exactly what I will be discussing in this blog.
A portfolio is basically a collection of financial assets like stock bonds, cash, ETFs, etc. A balanced portfolio can reduce your risk and increase your profits. And creating one is simple. You just need to answer two fundamental questions. Answering these two questions will tell you how you should design your portfolio. And those are What type of assets to buy and how much money to allocate for each asset.
I could have finished this blog in one screen share by showing you my portfolio and asking you to invest based on that. But that probably won't work for you because the two main ingredients involved in making a good portfolio are highly personal.
So in this blog, I will tell you what those two ingredients are and then explain how you can create a balanced portfolio from these ingredients.
What Assets to Buy - The Time Effort Factor
The amount of time and effort you are willing to put in, largely affects the type of assets you should have in your portfolio. Of course, you always got the option to pay someone to manage your investments for you. But here we are discussing about handling your investments by yourself. Ideally, based on the time it takes to manage them, we can classify investment into 3 levels.
1. Low effort
If you neither have the time or the interest but still don't want to be totally left out, then you belong to this category. And for those who are here, an automatic investment plan is the best way to go. One which you can set once and then forget.
2. Medium Effort
This is where I am, and I believe many of us would find ourselves here. We are ready to trade some part of our time and effort to maximize the returns from our investments. Here we are talking about a few hours every week to inform ourself about the latest trends in the market and then adjust our investments.
3. High Effort
The last category of investors are those who have the time and patience to analyze the market and time their investments accordingly. These are day traders, financial advisors, and investment bankers, who regularly go through stock prices, financial statements, and federal policies to decide the ideal place to invest their money.
Once we identify which level we fall into the time effort category, we can go to the second and most crucial factor.
How Much to Buy- The Risk Tolerance Factor
No investments are risk-free, and there is some risk involved anytime you invest money. And the return you get from your investment is the price you pay for the risk you take. This is the Risk-Reward concept. And the key to building the right portfolio is to balance risk and rewards. Unfortunately, many individual investors do not understand how to find out their personal risk level.
The first and most important step in calculating your risk tolerance level is to be aware of your financial goals. Be that be saving for your retirement, buying a house, or planning a vacation. Use that goal to calculate your investment time frame or the amount of time you can keep your money invested.
The longer your time frame, the more risks you can take. Also you need to be analyze your current financial situation. If you are at least 20 years off retirement age have a reliable income and some cash savings, your risk tolerance will be high. On the other hand, if you are nearing retirement age or may lose your source of income, your risk tolerance will be low. Let's classify the risk tolerance levels to low, moderate, and high for ease of understanding.
Now take a moment to think about which category you belong to in each of these two factors. How much effort you are ready to put in, and whats your risk tolerance level. Because what we are going to talk about now, depends mostly on where you stand on these factors.
Designing The Portfolio
Once we get more idea on which type of investor we are, we can start designing a portfolio around that. Now let’s draw a table and find out what are the available investment options in each category.
First we got Low Effort Low Risk investments.
The best investment with the least effort to maintain and lowest risk is a savings account. Though not technically an investment, they still offer you some returns and are completely safe due to account protection. But low-interest rates combined with high inflation make it the least attractive option nowadays.
Low Effort Medium Risk
If you can afford a bit more risk, a better option would be to invest in ETFs or exchange-traded funds. ETFs automatically follow a stock index, thereby requiring zero effort to maintain. They also bring in much-needed diversification for your portfolio across sectors, countries, and markets. If you are not familiar with an ETF, you can check this video where I talk about investment options in detail.
Ideally, you can invest in a global ETF such iShares Core MSCI World UCITS ETF USD (Acc) that gives you broad exposure to a wide range of global companies. Or the S&P500, which tracks the market performance of the 500 largest companies in the US. Here we can use the set and forget model. You set up your account to regularly transfer the desired amount from your bank and then forget about it.
Low Effort High Risk
This is gambling and something I would probably stay away from. My policy have always been Never Invest In in Something I Don't Understand. It would be foolish to invest in high risky assets without taking the time to understand the fundamentals behind them.
Now When we move to the medium effort category, we have more options.
Medium Effort Low Risk.
If you don't want to take much risk and still want to make better returns than a savings account, buying government bonds would be a good option. Bonds are securities issued by governments to raise money for government programs. You can buy US Treasury bonds from their website based on your investment time frame. They are backed by the US government, and as a result, the risk of losing your money is next to zero. But the returns here are also low compared to other investment options.
Medium Effort Medium Risk
This is a sweet spot to be in for a beginner investor in their 30s. Irrespective of the type of investor you are, it's always a good idea to set aside a part of your portfolio with ETFs such as the S&P500. In this case, you can also expand this to include ETFs from developed countries or specific sectors such as renewable energy. When you add some blue chip stocks to the portfolio, you increase the chance of making profits in long term.
Blue-chip stocks are the stocks or companies that are well established like Apple, Amazon, etc. Finally, to add some stability to the investment, you can also allocate a share of your portfolio to bonds. Even though you don't have to adjust your portfolio daily, you have to dedicate some time to analyze the performance of the markets and companies you have invested in. [60%ETFs, 30% Stocks, 10% Bonds]
Medium Effort High Risk
Remember the risk-reward concept (Spider Man Movie Scene)
But, That's spiderman. This is different. With more risk, comes more returns. If you're looking for high-growth potential and less concerned about immediate income and risk, then you may want to invest more aggressively in stocks. Small-cap stocks in particular. Small-cap stocks are shares of companies with a total market capitalization in the range of about $300 million to $2 billion.
They have the potential for high growth rates, making them very attractive investments. However, their stocks may experience more volatility and pose higher risks to investors. Avis Budget Group, which provides car rental services, and Coursera, which operates an online educational content platform, etc., are some examples of small-cap companies.
In the high risk category, you can also invest in bitcoin to diversify and bring a share of the crypto market into your portfolio. But keep in mind that crypto markets are highly volatile and speculative, and there is a good chance of losing all your money. A possible allocations strategy here would be 35% Blue Chip, 25% Small Caps, 20% ETFs, 10% Bitcoins.
The high effort category, consists of people who have enough time to analyze the markets daily and adjust their investment accordingly. We are talking about investment bankers, financial advisors and day traders. You will have to gather information from news articles, company reports, analyze the data in trading software and make decisions.
A day only has 24 hours, and I also got other things to worry about than managing my investments. And I believe most of you are in a similar state. So this is not for me and I will not talk much about something I am not familiar with. But those who are interested, could think of adding some penny stocks and altcoins into your portfolio.
If you have made up to this far in this blog, it shows that you are serious about growing your wealth. Hence I would suggest you to check this video, to understand some of the best stocks, ETFs, and bond options that beginner investors can start with. Finally, no amount of returns can buy you peace of mind. The perfect portfolio is the one that lets you sleep peacefully at night. Sit Back, Relax, and Enjoy the Journey.
Disclaimer: The Content is for informational purposes only, you should not construe any such information or other material as legal, tax, investment, financial, or other advice. It is important to do your own analysis before making any investment.
