A portfolio meaning can be referred to the bucket of financial instruments that an investor or an entity owns. It can include various investment options such as stock, mutual funds, debts, gold, real estate, etc. The main objective of the financial portfolio is to generate wealth over the investment period and achieve financial objectives.
In this blog, we will understand what is a portfolio, its components and their types. We will also deep dive into what you should consider for building an effective portfolio to achieve your financial goals in time.
What is Portfolio?
The portfolio definition may vary depending on the investment goals, risk tolerance, and financial situation of a person.
A portfolio includes different financial assets, such as stocks, bonds, mutual funds, real estate, bank fixed deposits, etc., that investors hold for a particular period. Having these multiple assets in the portfolio helps you to mitigate the risk involved in the specific investments and helps in generating maximum return over the period. A well-structured portfolio allows investors to diversify their investments, match risk with the risk appetite of the investor, and achieve financial goals in time.
What are the Components of a Portfolio?
| S.no. | Components | Description |
| 1 | Stock | A type of security that gives you a share of ownership in a company. These are considered highly risky investments due to their volatility. Due to the higher underlying risk in equities, they have a great potential to deliver high returns. Stocks can be further classified into large, mid, and small caps based on their market capitalisation. Sebi defines large-cap stocks as the top 100 companies per market capitalisation. Mid-cap stocks include companies with a rank between 101-250, and Small-cap stocks include companies starting from rank 251 onwards based on market cap. |
| 2 | Bonds | The government or companies use these instruments to raise money by borrowing from investors. These debt instruments offer you a regular rate of return through coupon payments. You also receive your investment amount or face value at maturity. These are considered less risky investments than stocks. They often offer lower returns on your investments than equities. |
| 3 | Mutual Funds | Mutual funds are an investment vehicle in which multiple investors pool their money to achieve a common objective. The fund manager then invests this pooled money across various asset classes such as equity, debt, gold, and other securities to generate returns. The fund manager makes the investment as per the investment objective of that particular mutual fund. The gains and losses from such investments are distributed to investors in proportion to their shares. |
| 4 | Gold | It is one of the oldest and most-loved forms of investment. The yellow metal is widely recognised and valued worldwide and is regarded as a safe-haven asset due to its propensity to increase in value during economic uncertainty or market volatility. You can invest in gold through various modes– physical gold in the form of jewellery, bars or coins; paper gold- via gold exchange-traded funds (ETFs) or government-backed Sovereign Gold Bonds (SGBs); or digital gold. |
| 5 | Real Estate | It includes investments in real estate properties such as residential houses, commercial shops, villas, etc. In this investment, you earn income through rentals and capital appreciation. You can invest in real estate by investing physically and through real estate investment trusts (REITs). Some new-age companies also allow you fractional ownership of real estate properties. They offer you regular interest income as well as capital appreciation. |
Types of Portfolios
You can create various types of investment portfolios to fulfill your goals. Your investment portfolio should be in sync with your risk appetite. Some of the most common types of portfolios are:
1. Aggressive Portfolio:
An aggressive portfolio aims to maximise returns while taking a relatively high degree of risk. This portfolio suits investors with high-risk tolerance capacities, like young investors or those with time to achieve a particular goal.
2. Conservative Portfolio:
This portfolio is designed for low-risk tolerance investors, such as those with short-term goals. A conservative portfolio will have a high allocation to low-risk fixed-income instruments and traditional investments. A conservative portfolio may have a small smattering of high-quality stocks. It is also known as a defensive portfolio.
3. Income Portfolio:
This portfolio is focused on regular income from investments. It includes investments in bonds, debt securities, as well as stocks which regularly pay dividends. This type of portfolio is suitable for a risk-averse investor who does not want to take any risk. Retirees who want regular income during their golden years may also prefer this portfolio.
4. Speculative Portfolio:
This portfolio is considered as most risky among all portfolio types. As in this portfolio, investments are made in risky instruments with the expectation of substantial gains in the future.
This may include betting on Initial Public Offerings (IPO) or stocks with growth potential, buying low-rated bonds or debentures for higher returns, or investing in options or futures contracts as a form of portfolio protection.
5. Hybrid Portfolio:
This portfolio primarily allocates your investments between two types of assets: equity and debt. While equities have the potential to produce high returns and build wealth, they also come with higher risks due to short-term volatility.
Conversely, debt includes interest-bearing securities that provide steady income and is generally considered a lower-risk asset class than equity. By blending equity and debt, which have a low correlation, the hybrid portfolio can reduce portfolio risk effectively.
How to Create a Financial Portfolio?
Creating a financial portfolio involves careful planning. To build a financial portfolio, you need to consider various aspects, including financial goals, risk tolerance, and time horizon.
Here’s a step-by-step guide to help you build a well-balanced financial portfolio:
Set Financial Goals: You should first define your financial goal. It can be a short-term goal like vacations, buying a car etc., whereas long-term goals can include saving for retirement, buying a house, children’s education or marriage.
Determine Investment Horizon: Another thing you should consider is the timeframe for investment. If it is a short-term goal, then you have to remain invested for 1-3 years; in the case of a mid-term goal, it is 3-5 years. And in the case of long-term goals, you have to remain invested for 5-plus years. So, you should decide for which duration you want to invest.
Assess Risk Tolerance: Next step is to understand your risk-taking capacity. It shows how much risk you can take in your mutual fund portfolio. You can use the know-your-investor-personality feature of ET Money to identify your risk tolerance.
Asset Allocation: After you have understood your risk-taking capabilities, you can proceed to invest your money. However, as it is always suggested, you should not invest all of your money in one single asset; you should allocate your investment to various asset classes to minimise the risk. Different assets have different risk levels. Equities are riskier compared to debt. Depending on your risk tolerance and investment goals, you can allocate money between various asset classes.
Investment Selection: Pick a suitable investment option based on your risk appetite and financial goals. You can select from various investment options such as stocks, mutual funds, ETFs, and bonds. However, before investing, you must review key details, including returns and past performance of the investment avenue you have picked. You can also compare it with its peers and benchmarks for a better understanding.
Monitor and Rebalance: You should regularly review your portfolio’s performance and adjust as needed. Rebalance your holdings periodically to maintain the desired asset allocation.
What is a Good Portfolio?
A good financial portfolio is one that is well-suited to your financial goals and risk tolerance. It should be well diversified and allocated so that it helps you in achieving long-term growth while managing risk effectively.
A good portfolio is one which helps you in achieving your planned financial goals. But, it is not a one-size-fits-all solution because every investor has different goals, objectives, and risk-taking capacities.
How to Measure Portfolio Risk?
Measuring a portfolio’s risk involves various quantitative methods, such as Standard deviation, Beta, Sharpe ratio, Shortino ratio, etc. But these quantitative methods are too difficult to use and time-consuming. In this situation, ET Money Portfolio Health Checkup comes handy.
It analyses your portfolio on the basis of 11 parameters, from asset allocation to the portfolio’s returns to management fees, and gives you a detailed summary of the risk involved in your portfolio.
You can use this feature to check your portfolio risk. It allows you to understand what is working for you and what is working against your portfolio. For instance, this feature allows you to determine if you have a concentrated portfolio inclined towards a particular asset class and suggest necessary changes to fix it.
Things to Consider Before Building a Portfolio
Risk-taking capacity: Risk tolerance shows the level of risk the investor is willing to take. It is the basis through which you choose the type of portfolio. For example, investors with a high-risk appetite may choose an aggressive portfolio by investing in high-risk stocks or mutual funds. However, the risk-averse portfolio may choose a conservative portfolio. You must invest as per the level of risk you are willing to take.
1. Financial Goals: One of the other determining factors for building a portfolio is your financial goals, which you want to accomplish. For example, if you are investing for your non-negotiable goal, like your child’s higher education, investing in very high-risk avenues may not be prudent.
2. Diversification: As an old and well-known saying goes, ‘Never put all your eggs in one basket,’ diversification is a tool that is used to reduce the risk in the portfolio by allocating your funds to different asset classes. Your portfolio should not be concentrated on one asset class but diversified among multiple asset classes. Diversifying your portfolio will cushion your investments from market shocks.
3. Investment Horizon: The investment horizon is the time an investor has to achieve a particular goal. It significantly impacts risk tolerance, asset allocation, diversification, portfolio rebalancing, and tax implication. Generally, an investor with a longer time horizon is comfortable with investing in equities. However, equities are not recommended for investors having a short investment horizon.
Usually, long-term investors can afford to take on more risk and may opt for a more aggressive portfolio.
Furthermore, they will benefit from a more aggressive asset allocation, greater diversification, and less frequent portfolio rebalancing.
Conversely, investors with short-term horizons or nearing retirement should stick to a less risky investment and may opt conservative portfolio.
Conclusion
Investors have various portfolio options, but caution is crucial when selecting the assets that best fit their investment goals. Choosing the right portfolio that aligns with your financial goals, risk tolerance, and investment horizon is essential. Also, regularly monitoring your portfolio is mandatory and should be rebalanced frequently to achieve your goals.
