How to Set Up a Portfolio
Establishing a healthy, dynamic investment portfolio is one of the best ways to achieve wealth and financial independence. Knowing your time horizon and risk tolerance level, as well as having an understanding of the many different vehicles available to investors today, is crucial to constructing a successful, risk-controlled portfolio.
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Instructions
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How to Set Up a Portfolio
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Establish your goals and time horizon. Know how much capital you have to work with, over what time, and what your estimated income and cash outflow situation is probably going to look like over the next 1 to 10 years. Investment objectives and risk tolerance levels tend to vary widely with factors like age, health, income, and job security. The more money you make from a job or business, and the younger you are, the more risk you can afford to take. If you are older, and at or near retirement, your main focus is likely to be conserving your capital and having a hedge against inflation. This will affect both the kinds of investments you can make, as well as how much of your capital you can afford to risk on these investments.
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Know how much risk you're willing to take. You can measure this in terms of dollars or percentage points. If you'll be purchasing stocks as an investment, decide whether you're willing to risk your entire principal, or if you'll establish the position with a pre-determined stop loss. For example, if you buy a stock at $20 per share, decide if you'll just leave the position alone, or will set a stop loss at $15, meaning the stock would be sold if it traded below $15 a share. Noone likes to lose, but in many instances getting out of a bad investment with a small loss is better than hanging on and watching the remaining value of the position dwindle away. In addition to managing your risk on individual positions, be sure to understand and control the risk of your portfolio at large. The most common tool used for this is Value at Risk, which is calculated using a synthesis of time, confidence level in your investments, and maximum loss percentage.
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Diversify your investments across types, classes, sectors, industries, and even countries. Diversification seeks to ensure that even if a portion of your portfolio loses value, another portion will go up to counterbalance it. Realize that in crisis environments, almost all investments have a correlation factor approaching one, meaning they move almost in tandem to the downside. In these environments, it's often best to be in cash.
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Be proactive in the management of your portfolio. Conventional wisdom holds that you should simply buy some mutual funds or a basket of stocks and hold onto them in perpetuity, while in reality it is often better to take profits when your holdings have appreciated, or trim losses when some of your positions have moved against you. You don't necessarily need to become a market timer, but be aware of the circumstances that affect your investments, and don't be afraid to actively buy and sell them when you need to.
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Tips & Warnings
Don't over-diversify. Only hold as many investments as you can thoroughly keep track of.
