To build a balanced investment portfolio, diversify your investments across different asset classes, such as stocks, bonds, and real estate. Consider your financial goals, time horizon, and risk tolerance to determine your right asset allocation.
Maybe you’ve heard the phrase, “Don’t put all your eggs in one basket”. That’s the key to building a well-rounded portfolio that both reduces your risk and helps you reach your financial goals.
A guide to creating a balanced and diversified portfolio
There’s no single right approach to investing. What works for you, your lifestyle, and your financial goals may completely differ from what suits another investor. This diversity is what makes investing fascinating — why there are numerous ways to create an investment portfolio.
But how do you actually build one? By the end of this lesson, you’ll learn the various portfolio types, the benefits of diversification, and how to start building your own portfolio.
How to manage an investment portfolio
Managing an investment portfolio is a fundamental part of wealth building.
Whether you’re saving for a specific goal like college, a home, or retirement, investment portfolios are a good choice for anyone looking to grow their income or nest egg.
The most common investments are stocks and bonds, but your portfolio can include various types of investment assets. Some investors opt for portfolios that include gold, real estate, cryptocurrencies, and other asset classes.
The key aspects of a well-rounded portfolio involve assessing your risk tolerance, diversifying your assets, and regularly rebalancing your asset allocation.
Determining your risk tolerance
Understanding your risk tolerance can help you determine the level of risk you are comfortable with, guiding you to pick investments that align with your personal preferences.
By assessing your risk tolerance, you can strike the right balance between risk and reward.
Some investors may be more conservative, preferring stable investments with lower potential returns, while others may be more willing to take on higher risks in pursuit of greater rewards.
The timeline of your investing goals matters, too. A helpful rule of thumb is to opt for riskier investments, like stocks or funds when your goals are further away. For closer goals, like car you’re buying next year, look for more conservative strategies involving bonds. or even cash.
Remember, your personal risk tolerance should guide your portfolio construction. This ensures that you don’t lose sleep over market fluctuations while still maintaining the potential for growth.
Building a diversified portfolio is closely tied to risk tolerance because it allows you to spread your investments across different asset classes with varying levels of risk. This diversification can help lower the impact of a single investment’s performance on your overall portfolio.
Understanding diversification
Diversifying your portfolio mitigates risk. This is because different asset classes tend to perform differently under varying market conditions.
When one asset is down, another may be up, providing a cushion against volatility. By selecting a mix of assets that suit your risk tolerance and financial goals, you can achieve a balanced portfolio.
Tip: Consider mixing up your investments with stocks, bonds, and cash, and vary the types of stocks and bonds you hold. This way, if one investment drops in value, others may compensate and help protect your overall portfolio from significant losses.
One easy way to achieve diversification is by investing in index funds and ETFs. These low-cost funds offer exposure to a wide range of stocks and bonds in a single security.
Achieving diversification with capital allocation
A diversified portfolio is built on the principle of capital allocation. It allows you to spread your investments to different asset classes, based on factors such as risk tolerance, market conditions, and investment objectives.
Your investment portfolio can include assets such as:
- Stocks
- Bonds
- Real estate investments, such as REITs
- Commodities
- Exchange-traded funds (ETFs)
- Cryptoassets
- Collectibles
By allocating your money smartly, you can potentially capture the upside of different asset classes when they perform well while mitigating the downside risk when others fall in value.
This approach helps to reduce the overall volatility of your portfolio and increases the likelihood of achieving stable long-term returns.
Tip: Investors must possess strong capital allocation skills to manage their desired risk level, returns, and financial goals.
Keep in mind that as market conditions change, your allocation can get skewed. For example, if one investment skyrockets, your portfolio’s stock percentage might shoot up too.
Rebalancing is the process of readjusting your portfolio through buying and selling assets. This ensures your allocation stays on track and aligns with your strategy.
Different types of portfolio allocations
When it comes to portfolio allocation, there’s no one-size-fits-all approach. The key is to find the right balance that suits your individual goals and risk tolerance.
If you don’t know where to start, here are the three most popular portfolio types: aggressive, moderate, and conservative.
Aggressive portfolio allocation
An aggressive portfolio allocation focuses on maximizing potential returns by taking on a higher level of risk. This approach is suited for individuals with a longer time horizon and who are comfortable with the volatility that comes with higher-risk investments.
The goal is to achieve substantial growth by allocating a significant portion of investments to high-growth assets such as stocks.
Typical focus: Stocks
Time horizon: 10 years or more
Example asset allocation:
- 80–90% in stocks
- 5–10% in commodities and/or crypto
- 0–10% in bonds
Moderate portfolio allocation
This allocation typically consists of a more balanced mix of investments, aiming to provide moderate growth while preserving capital. In a moderate portfolio, you can expect to find a blend of stocks, bonds, and cash.
A moderate allocation allows for potential growth through stocks while providing stability and income generation through bonds. Its focus is on achieving steady returns over the long term, offering a middle ground for those seeking a more balanced investment strategy.
Typical focus: Stocks and bonds
Time horizon: 0 to 10 years to retirement
Example of asset allocation:
- 60–75% in stocks
- 5–15% in bonds
- 0–5% in commodities and/or crypto
Conservative portfolio allocations
This strategy focuses on preserving capital and minimizing risk. It typically consists of a higher percentage of fixed-income securities, such as bonds and cash equivalents, compared to more volatile asset classes like stocks.
While the potential for high returns may be limited, this approach aims to provide stability and protect your investment against market downturns.
Typical focus: Bonds
Time horizon: Less than three years
Example of asset allocation:
- 30–60% — stocks
- 70–40% — bonds
Tip: Regardless of how low-risk a portfolio may seem, you should always be prepared for potential loss.
How to build your own diversified portfolio: 4 questions to ask
As you get ready to start building your own investment portfolio, here are four questions you should ask yourself. You can either tackle these considerations on your own or talk with a financial advisor who can help walk you through each step.
1. What are my financial goals and current life stage?
Understand what you want to achieve financially and consider your current life stage. Are you saving for retirement, buying a house, or starting a family? Your goals and life stage will shape your portfolio strategy.
Investors with few long-term commitments may choose a more aggressive portfolio, while those with financial obligations like a mortgage may benefit from a more moderate approach.
If you’re nearing or in retirement, a conservative portfolio may better suit your financial objectives and risk tolerance.
2. How will my asset allocation look?
Decide how you want to distribute your investments across different asset classes, such as stocks, bonds, real estate, or commodities. This allocation should align with your goals, time horizon, and risk tolerance.
By diversifying your investments across various asset classes, you can potentially reduce the impact of market fluctuations on your overall portfolio performance.
If you have a long investment horizon and a higher risk tolerance, you might allocate a larger portion of your portfolio to stocks. If you have a shorter time horizon or a lower risk tolerance, you might lean towards more conservative investments like bonds.
Diversifying your portfolio can also involve distributing your funds across various sectors, asset classes, and geographical regions.
For instance, if your portfolio only consisted of stocks, you could consider diversifying it as follows: 25% in international stocks, 25% in high-growth stocks, 25% in small-cap stocks, and 25% in value stocks.
This same approach can be applied to other asset types, including commodities and crypto. By tailoring your portfolio allocation to your needs, you can strike a balance that offers both stability and growth potential.
3.What is my risk tolerance?
Evaluate how comfortable you are with taking on risk. Are you willing to accept potential losses in order to pursue higher returns? Knowing your risk tolerance helps you determine the appropriate level of risk in your portfolio.
This question goes hand in hand with setting your financial goals. If you have a bigger tolerance for risk, you might be more willing to consider more volatile investments, like stocks or cryptocurrencies. If you’re less open to risk, consider safer investments like ETFs or blue-chip stocks.
4. What research do I need to do?
Once you’ve decided what types of assets you want in your portfolio, it is time to start determining which ones you actually want to add. Start reading up on the latest news and analysis, or pick out some potential targets and look into their performance history.
The more you know, the better equipped you’ll be to make informed decisions for your portfolio.
3 tips for creating a well-rounded portfolio
Think global and local
One good way to create balance in your portfolio is to have exposure to markets in the US as well as elsewhere in the world.
By diversifying your investments across different regions, you can reduce the impact of localized risks and take advantage of potential growth in various markets.
Keep an eye on international trends, economic indicators, and geopolitical factors that may affect your investments. By striking a balance between global and local investments, you can position yourself to benefit from both domestic stability and international growth.
Be ready to adapt
The world of investing is ever-changing, and staying ahead requires adaptability. Markets are influenced by many factors, including economic conditions, technological advancements, and social trends.
As an investor, it’s crucial to stay informed and flexible. Stay up-to-date with market news, monitor your investments regularly, and be willing to adjust your portfolio as needed.
Being proactive and ready to adapt to changing circumstances will help you seize opportunities and mitigate potential risks.
Don’t be afraid to rebalance
Over time, the performance of different assets within your portfolio can cause your allocation to drift from its original balance.
Periodically reassess your portfolio to ensure it aligns with your risk tolerance and investment goals. Adjusting the allocation of your investments can help you manage risk and potentially boost your returns.
Don’t let emotions dictate your decisions; instead, rely on objective analysis and consider rebalancing as a way to maintain the desired diversification in your portfolio.
Final thoughts
When building your very own portfolio, remember the power of diversification. Allocating your investments across different asset classes, such as stocks, bonds, and cash equivalents, is a key component of this.
By spreading your investments across a variety of assets, you can lower the risk associated with any single investment and potentially boost your chances of achieving consistent returns over time.
It’s important to be patient and try to take a long-term perspective. Investing is a marathon, not a sprint. Short-term market fluctuations can be unnerving, but it’s important to stay focused on your long-term goals.
Maintaining a disciplined approach, and resisting the urge to make impulsive decisions based on short-term market movements, can help you stay on track and potentially grow your wealth.
Visit the eToro Academy and learn how to build your own diversified portfolio.
FAQs
- What is the importance of building a diversified investment portfolio?
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Building a diversified investment portfolio is crucial because it helps to minimize risk and maximize returns. By spreading investments across different assets or asset classes, you reduce the impact of any single investment’s performance on your overall portfolio.
- How do I determine my risk tolerance?
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Consider factors such as your financial goals, time horizon, income stability, and personal comfort with market fluctuations. It is important to strike a balance between risk and reward that aligns with your individual situation and investing goals.
- What are the different types of portfolio allocation?
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There are three main types of portfolio allocation: conservative, moderate, and aggressive. A conservative allocation focuses on low-risk investments, a moderate allocation aims for a balance between risk and return, and an aggressive allocation emphasizes high-risk investments with the potential for growth.
- Can I have a mix of different allocation types in my diversified portfolio?
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Yes, it is common to have a mix of different allocation types in a diversified portfolio. For example, you might allocate a portion of your portfolio conservatively for stability and income generation while allocating another portion more aggressively for long-term growth. The specific mix will depend on your risk tolerance and investment objectives.
- How can I achieve diversification in my portfolio?
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Diversification can be achieved by investing in a variety of assets or asset classes, including stocks, bonds, real estate, commodities, and other investment vehicles.
It is important to spread your investments across different sectors, industries, and geographic regions to reduce the reliance on any single investment.
- How often should I rebalance my diversified portfolio?
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Rebalancing your diversified portfolio should be done periodically to maintain your desired asset allocation. It’s recommended to review and rebalance your portfolio at least once a year or whenever there’s changes in your financial situation or investment goals.
This communication is for information and education purposes only and should not be taken as investment advice, a personal recommendation, or an offer of, or solicitation to buy or sell, any financial instruments.
This material has been prepared without taking into account any particular recipient’s investment objectives or financial situation and has not been prepared in accordance with the legal and regulatory requirements to promote independent research. Any references to past or future performance of a financial instrument, index or a packaged investment product are not, and should not be taken as, a reliable indicator of future results.
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