In this guide, I will explain how to create a successful investment portfolio in 8 steps.
If you’ve been following the Foundation investing course, the following steps should feel like common sense. This article is the milestone where we can weave together many investing concepts we’ve explored so far. It’s time to put the knowledge into practice!
Why create an investment portfolio?
The first question you might be asking is why do we bother managing a large basket of investments? Why not invest all our funds in our favourite? The answers are twofold:
WHY AN INVESTMENT PORTFOLIO WILL ALWAYS WIN
Higher performance is the natural result of purposefuly directing your wealth into high-growth investments which suit your circumstances.
Spreading your money across an array of investments will reduce the overall volatility of your holdings.
How to build a simple investment portfolio
1: Check your time horizon
Review your personal situation and make a decision; just how long can you lock away your money in investments?
2 years? 10 years? 30 years?
A rule of thumb is to only invest in shares if you are sure you won’t need to access that money for 5 years or longer. For highly speculative investments such as investing in land, your horizon should be even longer term.
2: Understand your risk profile
Take my quick risk questionnaire to discover if you have the risk tolerance that will allow you to enjoy riskier investments.
Successful investing doesn’t require huge levels of risk though. Many investors enjoy a reliable return from conservative bonds and modest stakes in reputable businesses.
You will live with your investment portfolio for many years. It’s crucial that you are honest with yourself and pick investments which are compatible with your mind-set.
3: Choose a high-level asset allocation
An effective portfolio contains a mix of different ‘asset classes’, which are investments with different characteristics. Shares/Equities are one type of asset class, and bonds are another.
Blending different asset classes together in your portfolio is one of the diversification techniques which can enhance your return whilst reducing your risk.
Many investors opt for the following example asset allocations as a simple starting point. I have grouped these to correspond to the different investor risk profiles from my questionnaire.
Example Asset Allocation: Adventurous Investor
- 80% Equities | 20% Bonds
- 60% Equities | 20% Property | 20% Bonds
- 60% Equities | 15% Property | 15% Bonds | 10% Cash
Example Asset Allocation: Balanced Investor
- 60% Equities | 40% Bonds
- 45% Equities | 10% Property | 40% Bonds
- 45% Equities | 10% Property | 30% Bonds | 10% Cash
Example Asset Allocation: Cautious Investor
- 40% Equities | 60% Bonds
- 27.5% Equities | 7.5% Property | 70% Bonds
- 25% Equities | 5% Property | 50% Bonds | 20% Cash
Example Asset Allocation: Risk Adverse
- 20% Equities | 80% Bonds
- 10% Equities | 10% Property | 50% Bonds | 30% Cash
Asset allocations are like recipes. They are completely flexible and can be tailored to your preferences.
As a beginner, it makes sense to stick to a tried and tested allocation. But as you discover more about investing and gain more experiences, it’s natural to experiment and tweak your holdings.
The logic which drives this step is that higher equity allocations deliver higher returns, but introduce more risk. If the bond & cash allocations are increased, portfolio risk reduces, although so too does the expected return.
Remember that the portfolio is designed to meet your needs, which might not be typical. In my own asset allocation, for example, I give a large weighting to cash. This was in response to attractive government incentives on offer and my desire to buy a house in the short term.
4: Design a sub-asset class allocation
The portfolio examples above give only a high-level shape to your investments. It’s how you invest your money within those asset classes which defines its character.
Will you invest in small companies or large ones? Will your portfolio have a worldwide exposure or a national focus?
You answer these questions with your sub-asset allocation.
You will generally want to spread your money widely across different geographies, industries and company size. The more diverse the mix; the more resilient it will be to sudden shocks.
You may begin to appreciate that this step is just as important as step 3 in determining the risk and return of your portfolio.
A 40% allocation to equities could generate more risk than a 60% allocation if the sub-asset classes chosen in the first case were high risk, such as investing in emerging markets.
Therefore, you’ll want to consider your risk profile again when determining how to sub-allocate. I will use the example of equities to show what different sub-asset allocations could look like for different risk profiles:
Example sub-asset allocations for equities
- 30% UK large companies, 20% UK small companies, 30% worldwide, 20% emerging markets
- 50% UK large cap, 10% UK small cap, 30% worldwide, 10% emerging markets
- 70% UK large cap, 20% UK small cap, 30% worldwide
- 70% UK large cap, 30% worldwide
I increase the proportion of UK investments to reduce the risk level of equities. The UK is a relatively stable democracy, which poses no foreign exchange risk to a UK investor. I also reduce exposure to emerging markets and smaller listed companies as these are higher risk equity categories.
For corporate bonds, higher risk portfolios include generous quantities of ‘junk bonds.’ These are bonds with lower credit ratings and therefore higher yields. Cautious portfolios will feature bonds from trustworthy sources such as stable governments and large corporations.
Choosing your sub-asset allocation is the most judgemental phase of building your investment portfolio. Therefore, take your time. Resist the excitable urges to invest before you have sketched out the whole picture.
5: Choose an investing approach – funds v shares
Should you manage a portfolio of 20+ individual company shares, or buy a fund that invests in a basket of companies for you?
Our article How to invest in shares and the stock market lists the pros and cons of each approach.
Choosing a stockbroker before you’ve selected an investing approach is like walking into a restaurant before choosing a cuisine. Investment platforms are generally priced to suit one type of investor or another – so it’s important to know what type of purchases you’ll be making to ensure you’re choosing the right investment partner.
6: Choose a stockbroker or investment service
Choosing a stockbroker is difficult but exciting. Due to the massive choice of providers and services, you’ll can get lost.
Popular investment platforms in the UK include; Vanguard, Hargreaves Lansdown, Interactive Investor and Halifax.
7: Pick funds or shares within each sub-asset class.
On Financial Expert, I enthusiastically recommend taking the fund route over buying individual shares.
- Lower cost
- Ease & convenience
- Instant diversification
- Access to some investments that would be otherwise very difficult to access as a retail investor.
The industry leader Vanguard offers a range of funds with low management charges of less than 0.3% per year in common sub-asset classes.
Here is a glimpse of their selection of equity funds, which cover several of the sub-classes discussed above. Each fund is diversified across at least 20 individual holdings.
I encourage you to research Vanguard and their funds before you look elsewhere so that you can use their funds as a good benchmark.
Picking specific funds is a huge topic which I can’t hope to cover in this overview article. Please explore our other Foundation and Intermediate topics for further information.
8: Deposit funds and invest!
The final exciting step is to transfer money into your investment platform from your bank account to begin your investing journey.
Our article ‘How to invest in shares and the stock market‘ takes you step-by-step through the information you will need to execute a share purchase. Buying funds is even more straight forward.
Check out how to spot investment scams to learn about red flags and methods of checking the legitimacy of investments before you spend a penny. If you’re very interested in protecting yourself, immerse yourself my ultimate guide to online investment scams.
If you have landed on this article, and have enjoyed reading, why not visit our Foundation investing course page and start from the beginning?
How to Build an Investment Portfolio (For Beginners)
Understand your time horizon. If you can only lock money away for less than five years, then shares and other long term investments will not be a good fit.
Understand your risk profile. You need to be comfortable with the level of risk and the volatility that your portfolio might experience.
Choose a high-level asset allocation. Higher risk strategies use more equities and property. Lower risk portfolio's include more bonds and cash.
Design your sub-asset allocation. Divide your asset classes further by regions or by industry. This way, you will ensure that each asset class is as broad as possible.
Choose an investing method. Will you create your portfolio using lots of individual shareholdings and bonds, or will you use funds to quickly access instant diversification?
A saver who can invest £250 per month for 30 years, will likely earn £100,000+ more if they invest it in the stock market rather than a savings account. A life-changing amount of money is at stake.
Research individuals funds and shares to build your portfolio. If you are investing directly, you will want to ensure you have more than 20 individual holdings per asset class. If you are researching funds, stick to index-tracking funds with low fees.
Deposit funds and place your first trade!
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