A portfolio’s simple purpose is to act as the vehicle to get you, the investor, to your financial goals. There are many ways to achieve your goals and many different investments that can get you there. But a truly successful portfolio gives you the highest rate of return possible with the least amount of risk, suitable to your risk tolerance.
What is included in a portfolio?
- Stocks: This gives investors a share of ownership in a publicly-traded company. Stocks come with high risk and reward trade-offs. Historically, stocks do provide the greatest potential for growth for an investor.
- Bonds: A bond is a debt issued by a company or a government. The investor loans the money to the company or government in exchange for an interest rate over a certain period. Bonds are a secure investment compared to stocks. However, they have lower growth potential.
- Real Estate Investment Trusts (REIT): A real estate investment trust is a company that owns and operates income-generating real estate. To qualify as a REIT, companies must payout at least 90% of their taxable income to shareholders. That makes REITs a good source of dividends.
- Cash/ Cash Equivalents: Cash and cash equivalents are entirely liquid and are not subject to fluctuations in value. However, some cash equivalents do accumulate a small amount of interest.
Building your portfolio begins with understanding your risk tolerance. Every investor is different; you can be older, younger, have a long or short time horizon, have a pension, or need individual savings for retirement. Each of these factors will impact the amount of risk you can take as an investor. Not to mention each person has their innate risk tolerance.
It is essential to see where your investment risk would fall on a spectrum to begin choosing your portfolio. Risk when investing comes from purchasing stocks. Stocks provide the most potential for reward while also having the most risk. On the alternate end of the spectrum is fixed-income investments; Bonds and GICs have lower rewards but lower risk associated with them. Thus, introducing us to the risk-reward trade-off, the greater risk in your portfolio, the greater chance for reward.
Types of Portfolios
- Aggressive Portfolio: An aggressive portfolio is highly invested in stocks and a small portion if at all, invested into bonds or cash equivalents. These portfolios would be best suited for investors with higher risk tolerance. An aggressive portfolio is designed for the investor that prioritizes growth while being comfortable with the risk that goes along with potential reward.
- Conservative Portfolio: A conservative portfolio is primarily invested in Bonds, GIC, or cash equivalents, with a small portion, if at all, invested into stocks. These portfolios are best suited for an investor with lower risk tolerance. These portfolios are designed for investors who are not comfortable with the risk of losing their capital.
- Income Portfolio: An income portfolio’s main objective is to generate income at regular intervals for investors. Products such as bonds, real estate investment trusts, and dividend-paying stocks will be invested in these portfolios. These portfolios are great for retired investors that rely on their portfolios to generate income. However, generating income will mean a higher tax implication for this strategy.
- Socially Responsible Portfolio: A socially responsible portfolio’s main objective is to invest in companies that consider different environmental, social, or governance factors (ESG). For example, if you want to invest in companies with green initiatives and make decisions about the environment, this portfolio could be right. These portfolios can be structured to any risk tolerance level and help investors grow financially while supporting companies that believe in a like-minded cause.
The cliché ideology of diversification is not to have all your eggs in one basket. Or, more specifically, do not have the success of your portfolio depend on a few stocks or bonds. The fewer stocks you hold, the greater risk each one of those stocks faces.
Today there are many ways to diversify your portfolio, which can be done through already diversified products like exchange-traded funds (ETFs) or mutual funds. These products mimic a country, industry, or global index. True diversification occurs when you combine diverse sets of asset classes that do not correlate based on their returns; they react differently to market influences.
“Don’t look for the needle in the haystack. Just buy the haystack!” — John Bogle.
As time goes on with your portfolio, the different underlying asset classes will perform differently. And suddenly, one year later, a 60% stock portfolio is now worth 70% of your portfolio. Did your risk tolerance increase during that time? Likely not. Therefore, actions need to be put in place to get your portfolio back to the agreed-upon target mix, according to the target of each asset class.
Rebalancing in this scenario would be selling the stock portion of the portfolio and investing in bonds, cash, or real estate depending on your initial agreed-upon portfolio. Rebalancing is systematically buying low and selling high on your investments. Rebalancing encourages the investor to stay on their plan and not try to predict and speculate which asset class will perform best.
“The beauty of periodic rebalancing is that it forces you to base your investing decisions on a simple, objective standard.” – Benjamin Graham.
Why an advisor can help?
The most significant benefit to working with a financial advisor is an advisor will provide calculated, evidence-driven financial advice. When managing your finances, you can have a plan, but along the way, many investors get lost in their own cognitive biases and fears regarding the market.
An advisor’s job as a fiduciary is to act in the investor’s best interest. Working with a portfolio management expert will allow you to get a third-party, unbiased opinion on your risk tolerance & the selection of the correct portfolio for your goals. A professional’s recommendation to ensure a properly diversified portfolio.
Constant assessment and rebalancing to ensure your finances remain on target for your financial goals. Most importantly, providing the investor peace of mind knowing a capable professional manages their portfolio in their best interest.