Before creating an Investment portfolio it is important to set clear and realistic goals. Setting realistic goals, identifying reasons to invest, and self-realization regarding personal attributes that will impact your investment decisions and are important to acknowledge to have a promising investment.
A good start is to list investment goals with short term, medium-term, and long term in mind. Gathering different types of investments and working toward personal financial goals will not only provide the highest return but allow you to evaluate how much risk you are willing to take and how much you can take to attain said goals. Knowing what type of investments will meet your needs before investing is important.
Step 1: Set a Time Horizons
When beginning your investment portfolio consider time restraints; your current age, your immediate need for the money you are saving, your assumed life expectancy. Risk tolerance, risk aversion, available and future resources, inflation and taxes create the mix of investment you want to asset allocation. These attributes will directly impact your decision on whether or not specific investments will fit your needs. Fixed short term income investments, as well as cash investments, maybe the highest potential returns in a short amount of time.
Examples of Recommended Short Term Investments:
- Certificates of deposits
- Certain bonds
Some recommended long term investments such as equities have higher historic returns than other investments but do not guarantee future results. There are optimal mixes of assets that produce different returns with minimal risk. If you are younger and don’t have a fast fix for cash, allocating a large portion of investment dollars to more volatile investments, like stock are more beneficial to you in comparison to the recommendation a more mature 70 year old retiree who needs income and a more secure investment such as bonds and/or other fixed-income securities. Generally speaking the younger you are the more risk you can afford. As time progresses and there is a more demanding need for money and may need to increase the percentage of fix income securities in your portfolio.
Step 2: Allocate Resources
How much are you capable and willing to invest? If the availability of funds is limited your portfolio will reflect that and narrow your investment choices. When you are not only impacting your finances but also presenting and investing your entire net worth. Take inventory of all valuable things you own, subtract your debt and then you are provided with your net worth to gauge your risk tolerance for additional investments, how you have your assets allocated, and determine how much capital to invest and ways to allocate it.
Step 3: Identify Your Risk Tolerance
Risk tolerance is the amount of risk you can afford when selecting investment options. The more affordable the risk the less averse you can feel about it. This is a key factor in building the right investment portfolio. Not doing so will lead to rash decisions and worrying.
How do you measure your risk tolerance?
The ability to meet financial responsibilities regardless of the results of your investment will influence your aversion to risk. If you are someone with a higher net worth you might have the ability to afford to lose some investment. You may feel more comfortable about speculation regarding potentially volatile investments. This may include items like:
- Forward contracts
If you are a lower net worth individual with a lower tolerance for risk your best bet is to stick to conservative investments. Your best best would be to work with your advisor on investing in a mutual fund.
Mutual funds are ready-made portfolios of investments with their investment objectives. Mutual fund portfolio managers allocate the funds’ dollar to achieve different investment goals.
- Meet the goal of growth
- Concentrate on stock growth
- Allocate lesser amounts of the fund to bonds and cash
Mutual funds are set up with a certain percentage of stocks, bonds, and cash giving choices for personal criteria. Mutual funds for diversification and allocation build portfolios in a simple way as to not require a lot of capital and trading.
Investment risks can be measured by volatility of investments, which is the amount the price fluctuates about the previous price. To measure this fluctuation, representing this tool is beta. The higher the beta the higher the risk the lower the beta the lower the price. This is a useful tool in selecting investments for portfolios and to measure the risk.
So.. what does this all mean?
Knowledgeable investors build their portfolios by combining different investments to achieve their investment goals and reduce their investment risk. Amount of capital in one allocated to an investment within a portfolio determined by risk and reward of said investment. Combining investment s with different risk rewards characteristics reduce overall risk. The process the portfolio takes is called asset allocation.
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