Description
Transcript
Welcome to the “Build Your Portfolio” video lesson!
How many times have you heard the word “diversification” but didn’t understand how to do it?
In this video, you’ll learn how to allocate your capital to different investments effectively, in order to achieve your investment goals
Capital allocation refers to the process of distributing funds among different asset classes, such as stocks, bonds, real estate, and commodities, based on factors like risk tolerance, market conditions, and investment objectives.
Having good capital allocation skills is essential for investors if they want to attain the desired level of risk and return and reach their financial goals.
At a high level, asset allocation is composed of 5 steps.
Step 1 is where your portfolio is made out of a pie of 100% uninvested cash. This is your starting point.
In step 2, you get to decide how your portfolio will look, according to your investment objectives.
Take a look at these three types of potential portfolio allocations:
The aggressive, the moderate, and the Conservative.
Before we start, it is essential to remember that the holding period is as long as you don’t need the money beyond investing it.
The more aggressive portfolio allocation is less likely to have assets such as bonds and instead would focus more on stocks and other volatile assets.
This type may require more active trading due to high volatility.
The moderate-risk portfolio allocation would be more finely balanced between stocks and bonds, with small allocations to cash and high volatile assets.
The conservative portfolio allocation would differ again. The focus here is about capital preservation, and bonds and cash are typically the biggest holding in the portfolio.
This portfolio will have almost no trading activity since stocks and other high volatile assets make up a small percentage, and it may be suitable for those in retirement or very close to retirement.
Where you are in life is also something to consider when determining the appropriate investment portfolio.
For individuals who may not yet have many long term financial commitments, an aggressive portfolio might be the most suited to them, while someone with long term financial commitments like a mortgage or a family to support might find it more suitable to have a moderate portfolio.
For those who may be nearing retirement or have already retired, they might choose to transition to a more conservative portfolio.
Both as an active or passive investor, you can expand your portfolio diversification by allocating your funds among different geographic regions, sectors, and asset classes.
Suppose our equity exposure is 70%, as we discussed earlier. This 70% is the new 100% pie within the equities asset class, and we need to distribute this amount among various equity types.
A hypothetical allocation to the equity asset class could be 25% to international stocks, 25% to large growth stocks, 25% to small-cap stocks, and 25% to value stocks.
The same goes for other asset types. For example, you can choose a mix of crypto that is made of large-cap coins and new coins, and a mix of different commodities, such as different precious metals and different energy commodities.
Now that you’ve allocated your asset classes and the assets in each class, it’s important to periodically rebalance your portfolio to maintain the desired exposure and to ensure that it remains in line with your objectives and risk tolerance.
For instance, a 50/50 equity and fixed-income portfolio would involve investing $500 in bonds and $500 in equities. Suppose after three months, the equity portion increases by 50%, but the bond portion remains unchanged, resulting in a 60% equity and 40% bond allocation.
To rebalance the portfolio, the investor would sell a portion of their equity holdings to reduce the equity exposure to 50% and use the proceeds to buy more bonds, increasing the bond allocation to 50% which will bring back the portfolio back to a 50/50 balance.
Capital allocation is a crucial aspect of investment success, and it is advisable for investors to reassess their strategy at least once a year to further improve their potential portfolio outcomes.
So, there we have it!
The 5 steps of building your portfolio. Remember that you can always return to the eToro Academy and re-watch this video to make sure that you’re on the right track.
Until then, thanks for watching.