The decision to start investing for your future is the first of many steps you will take on your investment journey. What comes next is constructing a robust investment portfolio that supports your financial goals and objectives. This article aims tocover everything you need to know about creating a good investment portfolio.

What is investment portfolio?

An investment portfolio or a financial portfolio is a basket of financial assets that may include stocks, bonds, money market instruments, cash and cash equivalents, commodities, etc. Investors aim for significant returns by mixing these investment options in a way that best reflects their financial goals and risk appetite.

Importance of an investment portfolio

Following are some of the benefits* of creating an investment portfolio with appropriate mix of assets:

1. Potential

   Without an investment portfolio in place, investors might be unprepared for several major milestones in their life. A portfolio with an appropriate (diversified) mix of investments not only helps an individual protect her/his invested capital but also allows them to position it in a way that it has the potential to earn desirable returns. In the long term, this will allow investors to achieve their various financial goals, such as planning for their retirement, funding a child’s education/marriage, etc.

2. Income

   By developing an investment portfolio that centres around income securities, one can supplement their income in the future. For instance, when you dedicate a fraction of assets to dividend-paying stocks, you may create a stable income stream. Stock dividends are not usually assured but certain companies make uninterrupted payments over time. You can also invest in bonds to generate income, as these fixed-income securities generally make regular interest payments over the tenure of the investment**.

3. Diversification

   Having a financial portfolio by itself is not enough. An investor must judiciously allocate their capital to reap the benefits of being exposed to the risk of the financial markets. By creating a diversified financial portfolio that is spread across various investment categories, investors can reap the benefits of diversification. Diversification across multiple asset classes helps to protect an investor's capital if one sector of the financial market does not perform well.

Different components of an investment portfolio

The components of an investment portfolio consist of various securities known as asset classes. Investors must ensure that their portfolio has a good mix of assets to stimulate capital growth with controlled or limited risk. An investment portfolio usually has the following components:

1. Stocks

   Stocks are one of the most common components of an investment portfolio. They are a representation of the total share capital of a given company traded over the stock exchanges. Thus, if you are a shareholder, it means that you own a stake in the company. The size of the ownership stake is determined by the number of shares an individual owns.

2. Bonds

   Bonds are investment securities that allow the investor to lend money to the government, an agency, or a company for a fixed period of time in lieu of regular interest payments. Bonds have a fixed maturity date, post which the principal amount is returned to investors with interest. As compared to stocks, bonds are comparatively less risky but also offer lower potential returns.

3. Alternate investment options

   An investment portfolio can also contain alternate investments, i.e. assets whose value can grow and multiply, such as oil, real estate, gold, etc. Usually, alternate investment options are not as widely traded as traditional investments such as bonds and stocks.

What are the different types of portfolios?

There are different types of financial portfolios depending on the strategies used for investment. Some of these are:

1. Growth portfolio

The primary aim of a growth portfolio is to promote growth by undertaking more significant risks, including investing in growing companies. These portfolios usually offer significant potential rewards and concurrent higher risks both. Growth portfolios often invest in younger companies that have greater potential for growth than larger, well-established firms.

2. Value portfolio

Under these, an investor buys cheap assets by taking advantage of their low valuations. These portfolios are especially useful during challenging economic conditions when several investments and businesses struggle to survive and stay afloat. Investors search for companies that have profit potential but are currently priced below their fair market value. In short, value investing focuses on finding good bargains in the market.

3. Income portfolio

An income portfolio is more focused on obtaining regular income from investment options rather than focusing on potential capital gains. For instance, an investor might consider buying a stock based on its historic dividend payouts rather than its historic price appreciation. Moreover, fixed-income assets typically provide regular income to investors, making them ideal for those looking for stable returns.

Consider your risk appetite

Risk refers to the degree of uncertainty or potential financial loss that could arise due to the poor performance of the market or a particular asset class. Risk appetite or risk tolerance, in simple terms, means how much you can afford to invest and how much you can stand to lose without being financially affected when the markets are volatile.

Broadly, investors have three types of risk tolerance, namely low-risk, moderate risk, and high-risk. This is a tricky area to navigate and requires you to consider multiple factors such as the nature of your income, the number of dependents you have, your liquidity requirements, etc., to conclude where you fall on the risk spectrum.

If you need your capital in a few years and can’t stomach the ups and downs in the market, you have a low-risk tolerance. On the other hand, if you don’t need your money for a long time, say 15-20+ years, you can probably tolerate more volatility and the ups and downs of the market. You would have enough time to wait out a drop in your investment value, if any, before the market bounces back. Clearly, in this case, you have a high-risk tolerance.

You should always consider the investment horizon when building your financial portfolio. Everyone has a different risk appetite based on their life situations and financial goals. For instance, a college graduate could probably invest aggressively for a financially secure future as time is on his/her side. Meanwhile, a 55-year-old individual who is nearing retirement might not be able to risk a portfolio drop and will, thus, have a far more conservative investment portfolio.

If you have a high-risk tolerance, you might consider looking at high risk-reward investment avenues such as equity mutual funds^# or stocks that have the potential to offer inflation-beating returns in the long run. Keep in mind that they are subject to market risk but this is a trade-off you should be willing to accept.

On the contrary, if you think you want to lower the risk associated with investing in equties and play it relatively safer, you may consider investing in fixed-income securities such as debt mutual funds, recurring deposits, fixed deposits, etc. Remember, safety equals low to moderate returns, so the returns on fixed-income assets will not be the same as equities, as the former are less volatile.

Steps for building an investment portfolio

1. Preparation needed before building an investment portfolio

   Determine your current financial position. This includes listing down assets such as stocks, mutual funds, bonds, cash, property, etc., and liabilities such as debt, credit card dues, student loan debt, etc. This balance sheet will give you a clearer idea of your net worth and will also act as a benchmark for building your financial future.

2. Pay off your high-interest credit card debt

   It’s important to pay off your credit card debt as soon as possible. Follow these steps to ensure you don’t have any credit card debt:

   • Rank your debts by interest rate: On a piece of paper, rank all your debts with their interest rates in descending order.
   • Allocate as much as you can to clear your debt: Determine how much funds you can afford to allocate from your income each month towards paying the debt.
   • Consider the card with the highest interest as your priority: Pay the minimum balance on all your credit cards except the card with the highest interest rate. These cards should be paid off at the earliest.
   • Keep going: Continue paying off your debts until all your accounts are paid in full.

   The process of debt elimination might take a few months or even years. The key is to avoid making new charges and finding ways to make extra money to pay your debt faster.

3. Buy a house

   The next step in building your financial portfolio is to save for the down payment to purchase a house. By owning a house, you convert your rent liability into an asset. To sweeten the deal, the principal amount on home loans is eligible for tax deduction of up to Rs. 1.5 lac under Section 80C of the Income Tax Act, 1961. Moreover, even the interest paid on your home loan is exempt up to Rs. 2 lac per annum under Section 24B. You can also claim tax benefits on the registration charges, stamp duty, and other expenses that are directly related to the purchase of a house. These expenses can be claimed under the overall limit of Rs. 1.5 lac u/S 80C.

4. Build an emergency fund

   You must build an emergency fund that has at least six months’ worth of living expenses to cover any unexpected events such as job loss, surprise home repairs, medical emergencies, etc. Your emergency fund should be able to cover the following expenses:

   • Living expenses
   • Utility costs
   • Insurance costs
   • Mortgage payments
   • Fixed payments such as student loan, house loan, car loan, etc.
   • Minimum payment of credit cards

   
   Some of the best investment options to park your emergency funds are overnight funds, liquid mutual funds, savings accounts, money market instruments, etc. Remember, the primary objective of your emergency fund is safety and liquidity and not returns.

5. Look for other investment opportunities

   After completing the steps mentioned above, consider additional investment opportunities such as bonds, stocks, mutual funds, ETFs (exchange-traded funds), certificates of deposit (CD), etc. You can also opt for a financial advisor to guide you on your investment journey and help you chart the best way forward.

6. Invest in yourself

   If you are planning to stand out to potential employers, or improve your professional skills, or even start your own business, invest in yourself by undertaking valuable educational courses. This will enable you to increase your earning potential and accelerate your financial plans. Several colleges and universities offer various professional certification programs that you can take benefit of.

7. Save for your child’s future

   Every parent wants to ensure the best for their child, which includes providing them with good educational opportunities. However, with the costs associated with higher education growing at a rapid pace, it’s important to invest in your child’s future by building an educational corpus for them.

8. Stay on course

   By completing all these steps, you will have successfully laid the foundation for a successful financial future. The key to success is making informed decisions and sticking to your financial plan. Remember, wealth creation is a regular effort made by small and disciplined choices. You can also seek the help of a financial advisor who will help tobuild a financial portfolio for you to aid you on your journey.

Importance of a diversified portfolio 

Following are some of the benefits of a diversified portfolio:

1. Reduces the impact of market volatility

   A diversified investment portfolio helps minimise the overall risk associated with the portfolio. As investments are made across varying asset classes and categories, the overall impact of market volatility tends to decrease.

2. Helps seek advantages of different investment options

   By choosing different investment options such as mutual funds, ETFs, fixed deposits, etc., investors can enjoy the unique features of each instrument and mitigate risk. For instance, by investing in fixed deposits, an investor can enjoy fixed returns at lower risk, but with equity mutual funds, they have the potential to earn relatively higher returns as the risk is equally high.

3. Helps to preserve your capital

   Preserving capital is the basic criterion for several investors. Investors who have just started investing prefer to take risk while those that are on the verge of retirement prefer stability. Here’s where portfolio diversification can help them achieve their goals. Diversification allows investors to achieve their investment goals by limiting exposure to particular investments.

4. Helps manage risk

   At the core of a diversified portfolio are investment options that react to specific economic conditions. While an investor with a diversified their portfolio won’t achieve abnormally high returns as opposed to one owning a single, high-flying stock, they will also not suffer the ups and downs in the market like the latter. In short, an investor will generate weighted average returns on their underlying securities, but would also not be fully exposed to the volatility associated with a particular security.

5. Offers peace of mind to investors

   One of the biggest advantages of diversifying a portfolio is that it offers peace of mind to investors. When the total corpus is divided among a variety of asset classes and categories, an investor will not be stressed about the performance of the portfolio.

Achieving your long-term financial goals requires balancing risks against rewards. While there are several ways to invest, there’s no ‘one-size-fits-all’ approach to investing. So, choose the right mix of investments for your portfolio and make sure to rebalance and monitor your financial choices periodically. Remember, your investments should align with your financial goals, risk appetite, and investment horizon. Happy investing!

*The benefits are indicative in nature and the same may vary depending upon various market-linked factors.
**Returns on fixed-income investments are market-linked in nature and may vary.
#Mutual fund investments are subject to market risks. Read all scheme-related documents carefully.