A portfolio is a collection of investments held by an individual or institution, which is either managed by the investor themselves or by financial professionals. Portfolios usually consists of a mixture of financial assets such as stocks, bonds and other securities. By creating a portfolio, you diversify your investment and thus minimize risk. If you invest all your money in a single company and the company fails, you lose all your money. However, if you invest in a portfolio of different companies, you will only lose the portion of that investment.
Get a Plan
It is important to establish a detailed investment plan and to stick with it. Decide why you are investing and what your investment goals are. This will include the percentage of returns you are seeking, the risks you are willing to take on and the length of your investments. Stocks on average return more than bonds, but they also are considered more risky. If you are young and can afford more risk, you should invest in mostly stocks. If you are close to retirement and cannot risk losing your money, it is wise to invest mostly in short-term bonds. Moreover, the time frame of your investment dramatically changes what you should put in a portfolio. If you plan to invest for more than 10 years, your emphasis should be on growth and you should invest mostly in stocks. If you plan to keep your investment between five and 10 years, you should have a mixture of both stocks and bonds. Finally, if you only want to hold an investment for less than five years, you should invest in mostly dividend paying stocks, bonds and money-market funds.
Regardless of your goals, it is important to maintain a variety of assets in your portfolio. Theoretically, there is a reward for bearing risk. However, there is no reward for bearing any unnecessary risk. For every investment, there is a risk the company will perform poorly; there is also the risk that either the industry it is in or the entire market will perform poorly. By diversifying in a portfolio, you are minimizing the firm specific risk. The benefits of diversification decrease as stock or bonds are added to the portfolio, thus most portfolios include between 10 and 20 investments.
It is also important not to diversify too much or too little. You should diversify your security types, companies and industries. Moreover, you should have both financial assets such as stocks and hard assets such as real estate. As a result, you minimize the risk of losing a large portion of your investment if a single industry or market does poorly. However, if you diversify too much, you may also unnecessarily minimize the rate of your returns.