|Creating an Investment Portfolio
You've identified your goals and done some basic research. You
understand the difference between a stock and a bond. But how do you actually
go about creating an investment portfolio? What specific investments are right
for you? What resources are out there to help you with investment decisions? Do
you need a financial professional to help you get started?
A good investment portfolio will spread your risk
It is an almost universally accepted concept that most
portfolios should include a mix of investments, such as stocks, bonds, mutual
funds, and other investment vehicles. A portfolio should also be balanced. That
is, the portfolio should contain investments with varying levels and types of
risk to help minimize the overall impact if one of the portfolio holdings
Many investors make the mistake of putting all their eggs in
one basket. For example, if you invest in one stock, and that stock goes
through the roof, a fortune can be made. On the other hand, that stock can lose
all its value, resulting in a total loss of your investment. Spreading your
investment over multiple asset classes should help reduce your risk of losing
your entire investment.
However, remember that there is no guarantee that any investment strategy will be successful and that all investing involves risk, including the possible loss of principal.
Asset allocation: How many eggs in which baskets?
Asset allocation is one of the first steps in creating a
diversified investment portfolio. Asset allocation means deciding how your
investment dollars should be allocated among broad investment classes, such as
stocks, bonds, and cash alternatives. Rather than focusing on individual
investments (such as which company's stock to buy), asset allocation approaches
diversification from a more general viewpoint. For example, what percentage of
your portfolio should be in stocks? The underlying principle is that different
classes of investments have shown different rates of return and levels of price
volatility over time. Also, since different asset classes often respond
differently to the same news, your stocks may go down while your bonds go up,
or vice versa. Though neither diversification nor asset allocation can
guarantee a profit or ensure against a potential loss, diversifying your
investments over various asset classes can help you try to minimize volatility
and maximize potential return.
So, how do you choose the mix that's right for you?
Countless resources are available to assist you, including interactive tools
and sample allocation models. Most of these take into account a number of
variables in suggesting an asset allocation strategy. Some of those factors are
objective (e.g., your age, your financial resources, your time frame for
investing, and your investment objectives). Others are more subjective, such as
your tolerance for risk or your outlook on the economy. A financial
professional can help you tailor an allocation mix to your needs.
More on diversification
Diversification isn't limited to asset allocation, either.
Even within an investment class, different investments may offer different
levels of volatility and potential return. For example, with the stock portion
of your portfolio, you might choose to balance higher-volatility stocks with
those that have historically been more stable (though past performance is no
guarantee of future results).
Because most mutual funds invest in dozens to hundreds of
securities, including stocks, bonds, or other investment vehicles, purchasing
shares in a mutual fund reduces your exposure to any one security. In addition
to instant diversification, if the fund is actively managed, you get the
benefit of a professional money manager making investment decisions on your
Note: Before investing in a mutual fund,
carefully consider its investment objectives, risks, charges and expenses,
which are outlined in the prospectus that is available from the fund. Obtain
and read a fund's prospectus carefully before investing.
Choose investments that match your tolerance for risk
Your tolerance for risk is affected by several factors,
including your objectives and goals, timeline(s) for using this money, life
stage, personality, knowledge, other financial resources, and investment
experience. You'll want to choose a mix of investments that has the potential
to provide the highest possible return at the level of risk you feel
comfortable with on an ongoing basis.
For that reason, an investment professional will normally
ask you questions so that he or she can gauge your risk tolerance and then
tailor a portfolio to your risk profile.
Investment professionals and advisors
A wealth of investment information is available if you want
to do your own research before making investment decisions. However, many
people aren't comfortable sifting through balance sheets, profit-and-loss
statements, and performance reports. Others just don't have the time, energy,
or desire to do the kind of thorough analysis that marks a smart investor.
For these people, an investment advisor or professional can
be invaluable. Investment advisors and professionals generally fall into three
groups: stockbrokers, professional money managers, and financial planners. In
choosing a financial professional, consider his or her legal responsibilities
in selecting securities for you, how the individual or firm is compensated for
its services, and whether an individual's qualifications and experience are
well suited to your needs. Ask friends, family and coworkers if they can
recommend professionals whom they have used and worked with well. Ask for
references, and check with local and federal regulatory agencies to find out
whether there have been any customer complaints or disciplinary actions against
an individual in the past. Consider how well an individual listens to your
goals, objectives and concerns.
Stockbrokers work for brokerage houses, generally on
commission. Though any investment recommendations they make are required by the
SEC to be suitable for you as an investor, a broker may or may not be able to
put together an overall financial plan for you, depending on his or her
training and accreditation. Verify that an individual broker has the requisite
skill and knowledge to assist you in your investment decisions.
Professional money managers
Professional money managers were once available only for
extremely high net-worth individuals. But that has changed a bit now that
competition for investment dollars has grown so much, due in part to the
proliferation of discount brokers on the Internet. Now, many professional money
managers have considerably lowered their initial investment requirements in an
effort to attract more clients.
A professional money manager designs an investment portfolio
tailored to the client's investment objectives. Fees are usually based on a
sliding scale as a percentage of assets under management — the more in the
account, the lower the percentage you are charged. Management fees and expenses
can vary widely among managers, and all fees and charges should be fully
A financial planner can help you set financial goals and
develop and help implement an appropriate financial plan that manages all
aspects of your financial picture, including investing, retirement planning,
estate planning, and protection planning. Ideally, a financial planner looks at
your finances as an interrelated whole. Because anyone can call himself or
herself a financial planner without being educated or licensed in the area, you
should choose a financial planner carefully. Make sure you understand the kind
of services the planner will provide you and what his or her qualifications
are. Look for a financial planner with one or more of the following
CERTIFIED FINANCIAL PLANNER™(CFP®)
Chartered Financial Consultant® (ChFC®) and Chartered Life
Accredited Personal Financial Specialist (PFS)
Registered Financial Consultant® (RFC®)
Registered Investment Advisor (RIA)
Financial planners can be either fee based or commission
based, so make sure you understand how a planner is compensated. As with any
financial professional, it's your responsibility to ensure that the person
you're considering is a good fit for you and your objectives.