Deep Blue Publications Group LLC, Tips on building your portfolio when investing

Like every investor, you want to choose investments that will provide the growth and income you need to meet your financial goals. To do that, it’s important to understand yourself as an investor. That’s because a portfolio that’s right for someone else may not be best for you. The factors that make a difference are stated below.

Your risk tolerance

Both your age and your time frame for meeting specific financial goals play a role in determining your risk tolerance. If you’re young and have a long time to meet your goals, you may have a higher risk tolerance than someone who is nearing retirement and is counting on investment income to live on for two or three decades.

But other factors may also affect your tolerance for investment risk. Your personality, personal experiences, and current financial circumstances also come into play. For instance, if you’re a single parent, are responsible for the care of a sick or elderly relative, or have lived through a period of economic upheaval such as a major recession, you may be a more risk-averse, or conservative, investor. On the other hand, if you have a promising career, a generous salary, and little in the way of financial responsibilities, then you may be more comfortable in assuming greater investment risk.

Above all, you need to feel comfortable with the risk you’re taking. If changes in the value of your portfolio keep you tossing and turning at night, or your instinct is to sell your investments every time the market drops, then you may want to consider shifting to a more moderate investment mix, with a greater emphasis on predictable, income-producing investments, such as bonds.

Or, if you’re a risk taker by nature and have at least 15 years to meet your goals, then you may be comfortable allocating most of your assets to a diversified portfolio of stock, stock funds and certain fixed-income investments that have the potential to provide the strongest returns over the long run.

Keep in mind that investment risk doesn’t mean staking your life savings on highly speculative investments like a new company that a friend is starting. (The only money you’d want to put in investments like that is money you can afford to lose.) But it does mean getting used to the fact that virtually all investments that have the potential to provide substantial returns will drop in value at one time or another—sometimes significantly.

Using asset allocation

When you allocate your assets, you decide—usually on a percentage basis—what portion of your total portfolio to invest in different asset classes, usually stock, bonds, and cash or cash equivalents. You can make these investments either directly by purchasing individual securities or indirectly by choosing funds that invest in those securities.

As you build a more extensive portfolio, you may also include other asset classes, such as real estate, which can also help to spread out your investment risk and so moderate it.

Asset allocation is a useful tool in managing systematic risk because different categories of investments respond to changing economic and political conditions in different ways. By including different asset classes in your portfolio, you increase the probability that some of your investments will provide satisfactory returns even if others are flat or losing value. Put another way, you’re reducing the risk of major losses that can result from over-emphasizing a single asset class, however resilient you might expect that class to be.

For example, in periods of strong corporate earnings and relative stability, many investors choose to own stock or unit trusts. The effect of this demand is to drive stock prices up, increasing their total return, which is the sum of the dividends they pay plus any change in value. If investors find the money to invest in stock by selling some of their bond holdings or by simply not putting any new money into bonds, then bond prices will tend to fall because there is a greater supply of bonds than of investors competing for them. Falling prices reduce the bonds’ total return. In contrast, in periods of rising interest rates and economic uncertainty, many investors prefer to own bonds or keep a substantial percentage of their portfolio in cash. That can depress the total return that stock provides while increasing the return from bonds.

While you can recognize historical patterns that seem to indicate a strong period for a particular asset class or classes, the length and intensity of these cyclical patterns are not predictable. That’s why it’s important to have money in multiple asset classes at all times. You can always adjust your portfolio allocation if economic signs seem to favor one asset class over another.