4 Steps to build a Profitable Investment Portfolio in 2023
Creating an investment portfolio based on sound foundations is pivotal to the success of any investor in today’s money market. As an individual investor, you must learn how to segment your assets in a manner consistent with your investment objectives and risk appetite. In other words, your portfolio should generate as much return as possible with minimal risk, and not make you anxious.
In general, the formation of a successful investment portfolio aims to maximize wealth by increasing the benefit, in addition to reducing the size of the risks that the investor may face, but the problem at hand is how to determine the optimal composition or composition of the assets of the portfolio according to the criteria of return and risk?
4 steps to a successful investment portfolio
Investors can build portfolios compatible with certain investment strategies by following systematic methods. Here are four steps that will help you build a profitable portfolio in a systematic way during 2023:
1. Determine the appropriate asset allocation method for your situation.
Verifying your financial situation and goals is the first task in building an investment portfolio. Important elements to consider include your age, the amount of time you have to grow your investments, as well as the amount of capital you will invest and your future income needs. An unmarried college graduate who is starting his career needs a different investment strategy than a 55-year-old who wants to pay for his children’s college education and save a reliable amount after he retires in just 10 years.
The second factor to consider is your personality and risk tolerance. Do you want to risk losing some money in order to potentially make bigger returns? Everyone wants to achieve high returns year after year, but if you are constantly worried that the value of your investments will drop in a short period, the desired high returns will not be worth all the stress and stress in such cases.
Clearly defining your current situation, your future capital needs, and your risk tolerance will determine how you should allocate your investments among the different asset classes. The potential for greater returns comes at the cost of taking on the risk of greater losses (a principle known as the risk/reward tradeoff) – the point is not to avoid the risk factor entirely but to exploit it to suit your circumstances and your own investment style. For example, a young person who does not depend on his investments for a steady income can take greater risks in pursuit of higher returns. On the other hand, the person who is close to retirement age should focus on protecting his assets, obtaining income from these assets, and follow investment plans characterized by tax advantages that guarantee the payment of the lowest possible taxes.
Conservative investors vs impulsive investors.
The more risk you can take, the more impulsive your portfolio will be, and the greater part of your investment will go towards stocks, and the lesser part to bonds and other fixed-income securities. On the contrary, the less risk you can take, the more conservative your portfolio will be. Here are two examples of this: one for a conservative investor and one for an aggressive, moderate investor.
- 70-75% fixed income securities.
- 5-15% cash or its equivalent
- 15-20% shares.
The primary goal of a conservative portfolio is to protect its value, and the distribution pattern described above will result in stable income from bonds and will provide some long-term capital growth potential from investing in high-quality stocks.
Relatively aggressive wallet
- 50-55% shares
- 5-10% cash or its equivalent
- 35-40% fixed income securities
A relatively impulsive portfolio is suitable for medium risk tolerance, and attracts those who are able to take more risks in their portfolios in order to achieve a balance between income and capital growth.
2. The stage of creating an investment portfolio
Once you have determined the appropriate asset allocation method, you will need to allocate your capital among the appropriate asset classes. At the initial level of distribution it is not difficult, stocks are stocks, and bonds are bonds.
It will require you to break down the underlying asset classes into sub-categories with specific risk-return ratios. For example, an investor might allocate an equity asset class through a mix of companies and emerging markets to balance small companies with large growth potential against companies with larger, more stable businesses, and between domestic and foreign equities. The asset class of bonds can be distributed between short-term bonds and long-term bonds, between government debt and corporate debt, and so on.
There are several methods that you can use in selecting the assets and securities that fulfill your asset allocation strategy (you will need to analyze the quality and potential of each investment you buy, as bonds and stocks are not equal).
Stock Selection – Choose stocks that meet the level of risk you can handle in the equity portion of your portfolio. The share sector, market value, and type of shares are key factors that you must take into consideration. In the first stage, make an extensive list of potential companies and then filter them using stock screeners (software that helps filter stocks according to a wide range of criteria) to get a shortlist. In the second stage, you must conduct an in-depth analysis of each potential stock to determine its opportunities and risks in the future. This is the stage that requires the bulk of the work when adding securities to your portfolio, and requires you to monitor changes in the prices of your investments regularly, and follow the latest news of your stock companies in particular and sectors in general (for more information, read “4 steps to choosing a stock”).
Bond Selection – There are several factors you should consider when selecting a bond, including coupon value, maturity date, bond type and rating, as well as the general interest rate environment.
Mutual Funds – Mutual funds are available in a wide range of asset classes, and allow you to buy stocks and bonds that have been professionally researched by fund managers before selecting them. Fund managers will of course charge a fee for their services, which will reduce your returns. Index mutual funds are another option, and their fees are lower because they reflect an existing index and are therefore passively managed.
Exchange Traded Funds (ETFs) – This is a good alternative if you don’t want to invest in mutual funds. ETFs are, in essence, mutual funds that trade like stocks. They are also similar to mutual funds in that they represent a large basket of stocks – grouped by sector, capital size, country, or the like. But it differs in that it is not actively managed, but rather follows a specific index or other stock basket. Because they are passively managed, ETFs offer cost savings compared to mutual funds, while providing diversification at the same time. ETFs also cover a wide range of asset classes and are useful for complementing and diversifying your portfolio.
3. Portfolio reassessment.
After the portfolio is formed, it must be rebalanced periodically, because market movements may cause a change in the initial values of your investments. If you want to assess the actual distribution of assets in your portfolio, quantify the investments to determine their value compared to the total investments.
Other factors that are likely to change over time include your current financial situation, future needs, and risk appetite. If these factors change, you will have to adjust your portfolio according to the new changes. For example, if your risk tolerance declines, you may need to reduce the amount of stocks in your portfolio. Or you may become willing to take more risks and therefore may allocate a small percentage of your assets in stocks of small, high-risk companies.
If you want to perform a rebalancing, specify which asset class is over or under percentage. For example, let’s say you put 30% of your current assets in stocks of small or emerging companies (higher risk), while you are supposed to allocate only 15% of your assets in this category. Rebalancing determines how much you need to reduce in this category in order to allocate it to other categories.
4. Rebalance the portfolio in a strategic way
Try to maintain the distribution of assets that you have chosen in your investment strategy until you feel that the time has come, based on the data of your advanced age or the change in your financial situation, to change this distribution. One of the requirements to continue with your current asset allocation strategy is that you must rebalance your portfolio, or redistribute it completely from time to time.
When you decide it’s time to rebalance your portfolio, there are several approaches to doing so:
* You can sell part of the type of investment asset whose value has increased significantly, and reinvest its profits in another asset that has not yet increased.
* You can change how the new investment funds added to the portfolio are distributed, by placing them in other types of assets whose prices are still below their fair values, until the investor reaches the distribution that suits him.
* You can raise the capital of the investment portfolio, and allocate the increase to invest entirely in assets that are still below their fair values.
Use the method we discussed in Step 2 to select stocks when creating an investment portfolio for the first time.
*Note that when you sell assets to rebalance your portfolio, this will have tax implications which will reduce your returns. At the same time, you should think about the future of your investments. If you anticipate that overgrowth securities are about to collapse, selling them becomes necessary despite the tax implications. Analyst opinions and research reports are useful tools that help gauge the future of your investments.
Remember the importance of diversification
It is very important that you remember the importance of diversification and the need to maintain it during the entire process of creating an investment portfolio. It is not enough just to own securities in each asset class, you must also diversify in each class. Ensure that your investments in a particular asset class are spread across a variety of sub-categories and sectors.
As mentioned earlier, investors can achieve excellent diversification by using mutual funds and ETFs. These investment vehicles allow individual investors to take advantage of economies of scale enjoyed by large fund managers, which the average person would not be able to achieve with a small amount of money.
Generally speaking, an optimal investment portfolio that is well diversified is your best opportunity to increase the growth of your investments over the long term. They protect your assets from the risks of large downside movements and structural changes in the economy over time. Monitor your investments closely, making adjustments when necessary, and you’ll increase your chances of achieving significant financial success in the long run.
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