Do you want to start investing in the stock market? Have you ever wondered how to build a portfolio but don’t know where to start? If so, this article is for you.
We will cover how to create a stock portfolio from scratch. Keep in mind, building a stock portfolio is possible whether you’re a beginning investor or an experienced one.
What is an Investment Portfolio?
An investment portfolio is a collection of investments that investors choose to meet specific goals. The goal could be to save for retirement, create passive income, reach financial independence, or something else.
The key is the investments in the portfolio work together to reach the desired outcome.
A stock portfolio, for example, might include stock investments from different companies in different industries. Diversifying your portfolio would help spread the risk if one industry or company performed poorly.
A bond portfolio might have government and corporate bonds from around the world. Having this mix would give the investor exposure to different economies and interest rates.
A real estate investment portfolio might include commercial and residential properties in different geographic locations. Having this mix would diversify the risk if one property category or geographical region were to perform poorly.
It also might include REITs, which are securities that own portfolios of real estate assets.
An investment portfolio could also include a combination of the above and other investments in a broad asset allocation. The key is finding the right combination of assets for your specific goals.
Your investment portfolio could also reflect your beliefs, values, and interests. For example, if you believe in sustainable, ethical investing, you can include several mutual funds and ETFs in your portfolio. If you love new technology, perhaps you might want to invest in technology stocks.
Ultimately, you can build several different investment portfolios. Further, you can use a tax-advantaged account, taxable brokerage account or a combination of both.
Building an Investment Portfolio with Risk Tolerance in Mind
The first step to building an investment portfolio is determining your time frame and risk tolerance.
Your time frame might be short-term, such as months or a couple of years, or long-term, such as decades or a lifetime. Generally speaking, longer-term goals require more patience during market fluctuations than shorter-term ones do.
Risk tolerance determines how much volatility you can handle over time without cashing out your investments prematurely due to fear of losing money.
For example, suppose you have a high tolerance for risk and don’t mind seeing significant swings up and down within a given year (or even several years). In that case, you might be a good candidate for investing primarily in stocks.
If that amount of fluctuation feels uncomfortable to you, then you might consider an investment portfolio that includes a combination of stocks and bonds.
Choosing this asset allocation for your investment portfolio could provide stability since stocks tend to carry more volatility than bonds.
How to Build an Investment Portfolio from Scratch
Building an investment portfolio from scratch can seem like a daunting task, but it’s more straightforward than it seems.
The first step is to decide if you want help. Focus on asset allocation and risk tolerance, diversify, and choose investments for your age, goals, and investing timeframe. Then, choose the proper brokerage accounts.
Here is more detailed information about these steps:
1. Decide if You Want Help
Individuals, companies, and AI software can help you invest if you want financial advice to build your portfolio.
A financial advisor provides investment management, investment portfolio building, retirement planning, insurance needs and answers questions about other money matters.
They work with individuals, families, and businesses to create comprehensive plans that meet their unique goals.
There are two main types of advisors: commission-based and fee-only. Commission-based advisors get paid by the companies whose products they sell, in addition to potentially earning a fee for the investments they manage.
Fee-only advisors charge a flat fee for their services, regardless of the products they sell. This arrangement eliminates any potential conflicts of interest.
When choosing an investment advisor, it’s essential to ask about their experience, past performance, investment philosophy, and education.
Ask how they are compensated, what kinds of investments they recommend, and if a reputable organization accredits them.
Researching a CERTIFIED FINANCIAL PLANNER® in your area is typically an excellent place to start. It’s also a good idea to get referrals from friends or family members who have worked with an advisor in the past.
With a robo-advisor, you get all the benefits of a professionally managed portfolio without paying high fees.
Your money is automatically invested in a mix of stocks and bonds that corresponds with your age, risk tolerance, and investment goals. In other words, the program will create a diversified portfolio for you.
Robo-advisors are tax-efficient because they invest primarily in exchange-traded funds (ETFs), an investment vehicle that provides better tax-smart investing strategies.
Further, they charge fewer fees than traditional advisors because robo-advisors run on artificial intelligence, an algorithm that automatically adjusts your portfolio for you.
The fee you pay to a robo-advisor can depend on several factors, such as the amount of money you’ve invested, the type of asset allocation you choose, your investing strategy, or how often you rebalance your portfolio.
So is there a catch? Robo-advisors are not perfect, but no investment strategy is. They are excellent for average investors, not professional investors or aggressive investors.
They are also great for those who want help investing without high fees. However, they may not be suitable for you if you’re looking for personalized investment advice or feedback on your portfolio, even though some robo-advisor companies hire advisors that work with customers.
We recommend using Betterment, the original robo-advisor app. The investing app simplifies investing by breaking down your portfolio into low-cost index funds that align with your financial goals.
Consider using this service if you’d like to automate your investments into diversified index funds geared toward your desired financial outcomes.
If you have the time and interest to research stocks, ETFs, and mutual funds, and you feel confident in your ability to make informed decisions, then you could consider investing on your own.
First, do brokerage firm research to decide where to put your hard-earned money. Then, select which investments to put in your account.
When selecting stocks for your portfolio, you should consider factors such as company size, sector focus, dividend yield, earnings growth potential, and more. To reduce risk, you’ll also want to diversify your holdings across different sectors and countries.
Suppose you want to move forward with your research and invest on your own. In that case, you can access several available resources to help you get started, including books, stock research websites, stock screeners, stock picking services, online courses, and more.
The most significant advantage of DIY investing comes from creating a good stock portfolio and keeping costs low by avoiding fees charged by financial advisors and robo-advisors.
The disadvantage is that it takes time and effort to learn the ropes. Some particular funds might not be available to you due to high initial and ongoing investment minimums.
You’ll also need to be comfortable making investment decisions on your own, like how to balance paying back your student loans and credit card debt while also saving for your future.
2. Choose the Right Investment Accounts
When building an investment portfolio from scratch, choosing the proper investment accounts is essential.
For example, in addition to a retirement account, you might want to consider opening a high yield savings account.
You would make this decision so you can access cash when you need it for living expenses while still earning better interest than a regular savings account.
Also, consider opening a taxable brokerage account, especially if you want to access your investment money before retirement age.
If your work offers an employer match for retirement savings plans (e.g., 401k), it’s wise to take advantage of that as it’s essentially free money.
But, if you max out your retirement contributions and still have more room to invest, individual investors can use brokerage services to invest in both short and long-term goals.
What you’re aiming for is a combination of accounts in your portfolio that help you reach your short and long terms goals, have access to cash when you need it, maximize your tax benefits, and reduce the possibility for tax consequences.
It sounds like a tall order, but your portfolio can reflect all of these goals with time.
It gets tricky when you don’t have enough cash on hand to max out a retirement account and invest in a taxable brokerage.
In this situation, you’ll have to consider the importance of some of your short-term goals, like saving for a house down payment and weigh them against what you might need for retirement.
Every year might not be ideally in balance, and you might have to make financial compromises along the way. What’s most important, though, is you make a plan for your money each year and make the best decisions possible given your age, circumstances, and income.
3. Focus on Asset Allocation and Risk Tolerance
Asset allocation is the process of distributing your investment dollars among different asset classes. An asset class describes securities such as stocks, bonds, ETFs, mutual funds, cash, etc.
It’s a vital part of constructing a portfolio because it helps you manage risk while seeking to achieve your desired return.
There are many different ways to allocate assets. For example, you could go with a simple 60/40 stock to bond split for your asset allocation.
But as you get more advanced, you might consider adding other asset classes like real estate or commodities into the mix.
No matter what approach you take, it’s essential that your portfolio reflects your risk tolerance and investment style.
That means if you’re not comfortable taking on many risks to achieve potentially higher returns, then your portfolio should reflect that by having a more significant percentage of low-risk assets.
Conversely, suppose you’re OK with taking on more risk in exchange for potentially more significant rewards. In that case, you can weigh your portfolio more heavily towards stocks and other higher-risk investments.
The key is finding the right balance between expected returns and an acceptable amount of risk.
Here is a little more information about the most common portfolio assets.
A stock is a share in the ownership of a company. The goal of having individual stock ownership is to make money by selling them later for more than you paid at closing time, which results in capital appreciation.
You may also earn returns on your investments resulting from interest payments and dividend stocks.
Bonds are a loan that is made to a government or company. In return for lending the money, the bond issuer agrees to make periodic interest payments over a fixed period and repay the principal amount at maturity.
Bonds act as an income-generating asset for the holder and represent a tried-and-true passive income idea. Investing in bonds often differs from the investment objective for growth stocks: capital appreciation.
Exchange-Traded Funds (ETFs)
ETFs, also known as exchange-traded funds, are investment funds that hold assets such as stocks, commodities, and bonds. An ETF can be bought and sold on exchanges just like individual stocks.
A mutual fund is a collection of investments, usually stocks and/or bonds, managed by a professional money manager. Mutual funds offer investors access to professionally managed portfolios at relatively low costs.
An index fund is a type of mutual fund that tracks the performance of a specific stock market index or bond market index. Index funds are passively managed, which means they typically have lower fees.
Some professional managers offer actively-managed ETFs for higher fees.
Cash includes money market accounts, certificates of deposit (CDs), and money you hold in high yield savings accounts. Cash might be appropriate as a part of your portfolio if you have an investment horizon that’s short-term in nature.
Your overall portfolio will likely have a mix of cash and some of the investment options mentioned above. However, each investor will determine the percentages of each type of asset to include in their portfolio.
4. Practice Diversification
Stock diversification is an investment strategy used to reduce the volatility of a portfolio by investing in various types of stocks.
You can achieve diversification either through buying different companies from different sectors or by buying different types of stocks, such as growth stocks and value stocks.
Having a well-diversified portfolio is smart regardless of your age. The goal is to minimize the risk of investing in the stock market by simultaneously spreading your investment dollars across several stocks.
By spreading your money across many different investments, you reduce the chances of one significant loss affecting your entire portfolio.
5. Choose Suitable Investments for Your Age and Goals
For those in their twenties and thirties, you’re young enough that you can take on more risk by investing primarily in stocks. You have time on your side during the investment process to make up for any potential losses that may occur in the short term.
However, suppose you’re closer to retirement age or are looking to protect your savings for retirement income. In that case, it’s essential to invest in a mix of stocks and bonds, which will provide stability and modest growth over time.
It’s also important to know your why, your reason for investing. What financial goals are you trying to achieve? Some examples of common investing goals include buying a house, paying for children’s college, and retirement planning.
To achieve any one of these goals in a specific time frame, decide on an appropriate investment plan, even if you’re young.
If your circumstances, income, or plans change over time, you can continually update your goals accordingly.
6. Don’t Be Afraid to Take on Risk for Long-Term Investments
When it comes to long-term investments, don’t be afraid to take risks. By taking calculated risks with some of your money, you have the potential to grow your investment significantly over a long period. The key comes from knowing when to take risks and how much.
When you “take on risk” with your investments, you’re essentially saying that you’re willing to put your money into something that has the potential to give you a higher return. You could decide this means investing in stocks that carry higher levels of volatility.
One way to determine how much risk you should take is by looking at your time horizon. How long do you plan on holding onto the investment? If you have a longer time horizon, you can afford to invest in riskier assets.
Another thing to consider is your personal tolerance for risk. Some people are comfortable taking risks, while others shy away from the idea of losing money.
If you’re young, though, you have time to recover from losses, so don’t be afraid to take on risks when it comes to long-term investments.
Examples of long-term investments
- Real estate.
- Individual retirement accounts.
- Employer-sponsored retirement accounts (e.g., 401(k), 457 plan).
- Mutual funds.
- Target date funds.
- Individual stock investing.
7. Be Risk Adverse for Short-Term Investments
On the other hand, if you’re investing for the short-term, then it’s best to avoid high-risk investments that could result in a loss of capital. Short-term investments are essential for holding onto the money you know you will need in a few years.
Examples of short-term investments
- A savings account at the bank.
- A CD will give a guaranteed amount of interest and allow your investment to grow over time.
- A money market account is a savings account that typically offers a higher interest rate than traditional savings accounts.
- Government bonds.
- Cash and cash equivalents.
When choosing short-term investments, it’s essential to find something that offers a safe rate of return.
Investing in stocks is typically not considered a risk-averse investment, especially if you’re looking to hold the investment for a short period.
You Can Create a Stock Portfolio from Scratch
Building a stock portfolio can be intimidating at first, but by following these tips, you can create a well-diversified investment plan that will meet your individual personal finance needs.
Remember to always do your research before investing in stocks. It’s important to know what types of investments are suitable for you based on your age, investment goals, and investment time frame.
There are many resources available to help you get started with the process.
Creating a stock portfolio is just the beginning. You would also be best served by further learning how to start investing money in a diversified portfolio.