Whatever your investment goals are, deciding to build a diversified investment portfolio is one way to increase your chances of success. There is no single correct way of investing, but following a few simple guidelines can result in reduced risk and smoothed out returns, making the whole investment process easier to manage.
Building a balanced portfolio starts by giving some thought to what types of instruments you buy. Capital can be spread across different financial markets such as stocks, bonds, currencies, and cryptoassets. It’s also possible to spread risk across different geographical regions. Time is also a factor, and your approach to diversification might include investing in some assets you expect to make a return in the near future, and some with a longer investment time horizon.
A guide to creating a balanced and diversified portfolio
Watch this video to understand how to build a balanced, diversified portfolio.
How can you start building your own investment portfolio?
Here are four questions to ask yourself when you are getting ready to build your own investment portfolio. You can either tackle these considerations on your own, or engage a financial advisor who can help to walk you through these steps.
What are my financial goals and current life stage?
Do you want to try to find assets that you think will grow in the near future so that you can then sell them at a gain in the short term? Or do you want to take a longer view, with investments many consider less risky and more likely to show long-term profit that you can enjoy decades from now?
Investors without many long-term financial commitments may opt for a more aggressive portfolio allocation, while someone with long-term financial commitments, such as a mortgage, may be better suited to a moderate portfolio. For those who are close to retirement or have already reached retirement, a conservative portfolio could be a good match for their financial goals and risk tolerance.
How will my asset allocation look?
Asset allocation refers to how much of your portfolio is dedicated to each type of asset. Will you work on learning how to build a stock portfolio with nothing but shares? Or will you allocate some of your investment portfolio to cryptoassets or commodities? Also, how much of your portfolio will be dedicated to quicker growth (aggressive) and how much will feature generally lower levels of risk (conservative)?
As an investor, you may choose to diversify your portfolio by allocating your funds between various sectors, asset classes and geographical regions. For example, if your portfolio consisted only of stocks, you could look to diversify with 25% international stocks, 25% high growth stocks, 25% small-cap stocks and 25% value stocks. This same principle applies to other asset types, such as commodities and crypto, as well.
What is my risk tolerance?
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, whether they be shares or cryptocurrencies. If you are more inclined to defensive investing, ETFs or blue-chip stocks could be a better option for you.
What research do I need to do?
Once you have determined 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.
What is capital allocation?
Capital allocation refers to the process of distributing funds among 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
- Other types of investments, such as physical property, art and even high-end collectables and jewellery.
But the kinds of investments you can include in your portfolio are not only limited to the types of asset. It can also include different industries, risk levels and other diversification factors.
Tip: Portfolio balancing is an ongoing process. The positions you hold will need to be adjusted over time.
Diversifying your portfolio can help to mitigate risk. If one type of asset sees a significant drop in value, the value of your diversified portfolio might not be as hard hit. For example, the share market might experience a price correction at the same time that crypto markets rally.
By including different types of assets, your portfolio will not be dependent on just one market, therefore, potentially shielding you from too much damage to its value at one time. The same goes for industries — if the property market or technology sector were to struggle, your commodities assets or consumer staples shares might help compensate for that.
Are there different types of investment portfolio allocations?
Yes, there are different types of investment portfolio allocations. These are determined by the types of assets in which you choose to invest in and add to your portfolio.
Many investment portfolios are generally classified by the type of assets included in them. A stock portfolio will feature a range of shares in companies, while a cryptocurrency portfolio will focus on digital currency.
If you want to mix up what is in your portfolio, you can opt for a hybrid portfolio, which can include assets, such as stocks and crypto, and also property, art and other investments.
However, even portfolios that contain the same type of asset, or focus on the same overall industry, can still differ greatly based on several factors. For example, growth stocks and dividend stocks are both equities but offer two different kinds of returns to investors.
In addition to the actual assets in the portfolio, you can also classify portfolios by allocation type. Some common examples include:
- Aggressive portfolio allocations
- Moderate portfolio allocations
- Conservative portfolio allocations.
Aggressive portfolio allocations
An aggressive portfolio will usually have assets that can lead to greater gains more quickly, but also might come with greater risks. For instance, many of the stocks in an aggressive portfolio will be focused on fast growth. This type of portfolio allocation may require more active trading due to high volatility.
Typical focus: Stocks
Time horizon: 10 years until retirement
Example of asset allocation:
- 80–90% — stocks
- 5–10% — commodities and crypto
- 0–10% — bonds
Moderate portfolio allocations
Moderate portfolio allocations are generally more finely balanced between stocks and bonds, with smaller allocations of cash and other more volatile assets.
Typical focus: Stocks and bonds
Time horizon: 0 to 10 years to retirement
Example of asset allocation:
- 60–75% — stocks
- 5–15% — bonds
- 0–5% — commodities and/or crypto
Conservative portfolio allocations
A conservative portfolio allocation focuses primarily on capital preservation and is generally composed of what are considered to be low-risk investments, such as bonds and cash. These assets may be less impacted by changing economic cycles and major events.
Unlike an aggressive portfolio allocation, this type of portfolio allocation will have almost no trading activity since stocks and other high volatility assets make up a small percentage of the total portfolio. It may be suitable for those in retirement or close to retirement.
Typical focus: Bonds
Time horizon: Close to retirement
Example of asset allocation:
- 30–60% — stocks
- 70–40% — bonds
Tip: It is important to remember that regardless of how low-risk a portfolio may seem, you always need to be prepared for loss.
How can you create a balanced portfolio?
Here are a few tips for creating a balanced portfolio.
- One good way to create balance in your portfolio is to have exposure to markets in your local country as well as elsewhere in the world.
- For example, if you are an Australian planning on including indices as part of your portfolio, you could consider investing in both the ASX 200 and the S&P 500 to include both the domestic market and the US market.
- As you hold your portfolio over a number of years, different types of assets might become more helpful in keeping it balanced.
- Think about those investors who were trying to create a balanced portfolio 10 years ago — would they have imagined that cryptocurrency would be an option?
- Do not be afraid to adapt to not only different types of investments, but also traditional options that you previously had not invested in.
- Part of creating, and keeping, a balanced portfolio is being willing to rebalance as needed.
- Rebalancing your portfolio is important in maintaining your desired exposure and in ensuring that your asset allocation aligns with your risk tolerance and investing objectives.
- If you see your portfolio is too reliant on one type of asset — if too much of its value is attributed to one thing — consider a rebalance.
- Some investors set specific check-in dates, every six months or yearly, to see if they need to rebalance by selling or buying assets.
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Quiz
FAQs
- How is asset allocation decided?
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Asset allocation is simply the percentage of each type of asset that your investment portfolio contains. When allocating your assets, consider your age and investment aims. Single investors in their 20s will have a drastically different investment portfolio than someone in their 40s or 50s who plans on retiring soon.
- What is a risk-return profile?
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This determines how much risk an investor is willing and able to take on to achieve their aims. It is a key part of the process of building a portfolio strategy that can deliver the required returns with an acceptable level of risk.
This information is for educational purposes only and should not be taken as investment advice, personal recommendation, or an offer of, or solicitation to, buy or sell any financial instruments.
This material has been prepared without regard to any particular investment objectives or financial situation and has not been prepared in accordance with the legal and regulatory requirements to promote independent research. Not all of the financial instruments and services referred to are offered by eToro and any references to past 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.
eToro makes no representation and assumes no liability as to the accuracy or completeness of the content of this guide. Make sure you understand the risks involved in trading before committing any capital. Never risk more than you are prepared to lose.