The investment portfolio that’s right for you depends on your goals and the level of risk you’re comfortable with.
What do you want to accomplish? How fast do you want to reach your goals? What timeline are you working with?
Your answers guide which kinds of assets might be best for your portfolio—and where you’ll want to put them. When choosing or constructing an investment portfolio, you’ll need to consider:
Asset allocation: Choose the types of assets you want in your portfolio. The right asset allocation balances risk and reward according to your goals. Got big long-term plans? You may want more stocks in your portfolio. Just investing for a few years? Maybe play it safe, and lean more on bonds.
In this guide, we’ll:
- Explain what an investment portfolio is
- Explore the types of assets you can put in your portfolio
- Discuss how risk and diversification influence your portfolio
- Explain how to choose the right investment portfolio
What’s an investment portfolio?
When it comes to your financial goals, you don’t want your success or failure to depend on a single asset. An investment portfolio is a collection of financial assets designed to reach your goals.
The portfolio that can help you reach your goals depends on how much risk you’re willing to take on and how soon you hope to reach them. Whether you’re planning for retirement, building generational wealth, saving for a child’s education, or something else, the types of assets your portfolio includes will affect how much it can gain or lose—and how long it takes to achieve your goal.
What assets can your portfolio include?
Investment portfolios can include many kinds of financial assets. Each comes with its own strengths and weaknesses. How much of each asset you include is called asset allocation.
- Cash can be used right away and carries very little risk when compared to other asset classes. But unlike most other assets, cash won’t appreciate more than inflation.
- Stocks represent shares of a company, and they tend to be more volatile. Their value fluctuates significantly with the market. More stocks means more potential gains, and more potential losses.
- Bonds are like owning shares of a loan whether made directly to companies or governments. They tend to be more stable than stocks. There’s less potential for gain over time, but less risk, too.
- Commodities like oil, gold, and wheat are risky investments, but they’re also one of the few asset classes that typically benefit from inflation. Unfortunately, inflation is pretty unpredictable, and commodities can often underperform compared to other asset classes.
- Mutual funds are like bundles of assets. It’s a portfolio-in-a-box. Stocks. Bonds. Commodities. Real estate. Alternative assets. The works. For a fee, investors like you can buy into a professionally managed portfolio.
- Exchange traded funds (ETFs) are similar to mutual funds in composition–they’re both professionally-curated groupings of individual stocks or bonds–but ETFs have some key differences. They can be bought and sold throughout the day, just like stocks—which often makes them better for tax-loss harvesting. They also typically have lower fees as well. ETFs are an increasingly popular portfolio option.
Why diversification is key to a strong portfolio
Higher levels of diversification in your investment portfolio allow you to reduce your exposure to risk that hopefully will result in achieving your desired level of return. Think of your assets like legs holding up a chair. If your whole portfolio is built around a single asset, it’s pretty unstable. Regular market fluctuations could easily bring its value crashing to the floor.
Diversification adds legs to the chair, building your portfolio around a set of imperfectly correlated assets. With a diverse portfolio, your gains and losses are less sensitive to the performance of any one asset class and your overall portfolio becomes less volatile.
Price volatility is unavoidable, but with the right set of investments, you can lower the overall risk of your portfolio. This is why asset allocation and diversification go hand-in-hand. As you consider your goals and the level of risk you’re comfortable with, that should guide the assets you choose and the ratio of assets in your portfolio.
How to align your portfolio with your goal
Since some asset classes like stocks and commodities have greater potential for significant gains or losses, it’s important to understand when you might want your portfolio to take on more or less risk.
Bottom line: the more time you have to accomplish your goal, the less you should worry about risk.
- For goals with a longer time horizon, holding a larger portion of your portfolio in asset classes more likely to experience loss of value, like stocks, can also mean greater potential gains, and more time to compensate for any losses.
- For shorter-term goals, a lower allocation to volatile assets like stocks and commodities will help you avoid large drops in your balance right before you plan to use what you’ve saved.
Over time, your risk tolerance will likely change. As you get closer to reaching retirement age, for example, you’ll want to lower your risk and lean more heavily on asset classes that deliver less volatile returns—like bonds.