The investment portfolio for dummies
“Investment Portfolio” is definitely one of the terms we hear most often when it comes to investing. Let’s clarify what it is and what are its characteristics.
The investment portfolio is a set of financial assets appropriately combined to achieve a goal. Said simply, your portfolio is the set of all financial products and strategies on which you decided to invest.
Benefits of a diversified investment portfolio
The term portfolio goes hand in hand with another term, that is “diversification“. Yes, because the ultimate goal of having an investment portfolio is to combine different types of instruments that operate in different ways in order to reduce the overall risk of the investment.
If you have only instruments similar to one another, you run the risk of being unbalanced in both directions, both when you earn, but especially when you lose.
Try to imagine what would be your reaction if, at one point, you would see your whole portfolio losing. Of course, on the other side at times you would see everything also in profit, but you’ve already learned that it is much more important to dwell on the critical moments reactions, those in which there are difficulties and you need to hold your nerve.
In addition to this type of logical considerations, the creation of a well-diversified investment portfolio has been the subject of large number of professional and academic studies, obviously all based primarily on statistics.
The diversification and the statistics
It has been studied that the risks related to a well-diversified portfolio are statistically lower than those of a little or non-diversified at all portfolio.
In the case of stocks and bonds you can make different hypotheses. Considering bonds as the safer and stocks as the more risky ones, you can outline different portfolio methods. An investor who wants a conservative portfolio, with low-risk, will allocate at least 2/3 of capital to the purchase of bonds, maybe a small part in deposit fund, and the remainder will be spent in equities (stock market).
Vice versa, for those who prefer a more aggressive portfolio, with higher risks but also higher revenue prospects, at least 2/3 of the capital will be allocated to equities, and the remaining on bonds and funds.
Obviously these are very general and indicative guidelines. Within this framework we can build much more specific portfolios, based on the investor’s preference. In fact, not only you can choose between stocks and bonds, but also between different types.
Taking bonds into consideration, there are different categories based on their level of safety and return, and to identify them we use the rating agencies (Standard & Poor’s, Moody’s and Fitch) and the so-called “Rate” (ie votes like AAA, AA+, BBB etc).
So, if you wanted a more conservative portfolio, of the 2/3 of bonds you may allocate a 65% in government bonds or supranational entities, with a AAA or AA+ rating, and the remaining in bond with lower rating but more profitable coupons rate.
Same goes for stocks. For a more conservative approach, you can choose the shares of companies that generate solid revenues in the long term, or to be more aggressive you can choose young companies that are supposed to make leaps and bounds in the short term.
In other terms, we can say that building a portfolio is literally like making a bespoke suit. Obviously, this is also reflected in case of investments in strategies replication, such as Social Trading.
Investing the entire capital on a single Signal Provider is not the best solution.
Again, getting to know the parameters which we’ll analyze the performance of a trader with, you can distinguish the more conservative Signal Provider rather than the more aggressive, and work the same way in building a balanced portfolio according to your personal risk tolerance.
To conclude, there is only a risk when it comes to building an investment portfolio and diversifying, and it’s to exaggerate. As with all things, you need the right balance. Warren Buffet said that
“Wide diversification is only required when investors do not understand what they are doing”.