When it comes to personal finance, sometimes it seems like there’s a whole new language that you need to learn. There are terms like expense ratios and asset allocations. One thing you’ve probably heard about is a portfolio. Investment portfolios come up any time you talk about investing. That includes investments that you make into a retirement account, like a 401(k), as well as any other investments in the stock market. But what exactly is an investment portfolio?
What Is an Investment Portfolio?
In finance, an investment portfolio is a collection of all your investments. This can include stocks, bonds, cash, real estate or other assets. An asset is something that you invest money in with the hope that it will build future wealth. Assets vary widely. To make things simpler, we group them into a few asset classes. Common asset classes include stocks, bonds, real estate and cash. But no matter what you invest in, it’s a part of your investment portfolio.
Asset Classes in a Portfolio
The most common representation of a portfolio is as a pie. The pie represents all of the money that you have invested. The slices of the pie are how much you have invested in certain asset classes.
The three main asset classes are equities (stocks), fixed-income securities (bonds) and cash equivalents. The proportion of each asset class in a portfolio is the asset allocation of that portfolio. For example, someone might have 50% of their investment dollars in stocks, 40% in bonds and then 10% in a money market account.
All three of these asset classes can also break down into smaller groups. Investing in equities could include stocks from individual companies or stocks in a fund like an index fund or ETF. A fund simply consists of multiple individual stocks that you trade all together under one price.
There are multiple kinds of bonds. A bond is classified by the issuer of the bond and how likely that issuer is to repay you for the bond’s full value. Some common examples are treasury bonds, investment-grade corporate bonds and high-yield corporate bonds (also known as junk bonds).
Cash equivalents include accounts that you can deposit and/or withdraw money. Cash equivalents have little chance of losing value based on the stock market or a change in interest rates. Common types of cash equivalent accounts are money market accounts, certificates of deposit (CDs) and Treasury notes.
There are also asset classes outside of the main three. Some people include real estate investments in their portfolios. People may also trade in commodities, such as gold.
Starting an Investment Portfolio: Risk Tolerance
Risk is the potential for your investments to lose money when a company or market doesn’t perform well. There is always a degree of risk when you invest. If you absolutely cannot afford to lose your money, you might want to consider putting it into a savings account or CD. The FDIC insures both of these. That means you won’t lose all your money the way you might with a stock.
Your risk tolerance is the amount of variability and fluctuation you can handle with your investments. If you need your money in a few years and you can’t afford to lose any of it, you have a low risk tolerance. Someone who won’t need their money for 40 years can probably tolerate more variability. They have time to wait out a decrease in the value of their investments. Each of us has a different tolerance for risk based on our goals and our life situation. That risk will determine the way we handle our portfolios.
Starting an Investment Portfolio: Asset Allocation
As mentioned above, an asset allocation is the proportion of different asset classes in a portfolio. The best asset allocation for your portfolio will depend on many factors. If you are just getting started, you should reach out to a financial expert to make sure you understand how different investments could affect you.
As you think about your asset allocation, keep in mind that asset classes are broken down into smaller categories. For example, stocks vary hugely from company to company. That’s why people break down the asset class into smaller categories. This allows you to group similar stocks and then use them to diversify your portfolio. This is especially common with exchange-traded funds (ETFs).
An ETF is a fund that includes a number of similar stocks. That could mean stocks from a certain sector of the economy or even stocks from different countries. An ETF could invest only in large, established companies or only in small companies with high growth potential. Investing in multiple types of ETFs will diversify your overall stock investment because you’ll be putting money into funds that behave differently in certain economic conditions. Most robo-advisors actually invest their clients’ money in ETFs.
So as you think about your investments, financial advisors recommend that you create a diverse investment portfolio. That means investing in multiple asset classes. It also means choosing diverse options within an individual asset class. Again, you should talk with a financial expert if you have any questions. They’ll be able to guide you as you start investing.
Investing is a common way to build wealth – especially when planning for retirement. Any time you invest, you have to create an investment portfolio. Your investment portfolio is simply all the assets that you investment your money in. There are many ways to invest though. The main asset classes that people have in their portfolios are equities (stocks), fixed-income securities (bonds) and cash equivalents. There are other asset classes, like real estate, and the classes also break down into smaller categories. With so many ways to invest, it’s always best to consult a financial expert, like a financial advisor, if you’re just starting out.
Ways to Plan for Retirement
- A great way to plan for retirement is to calculate how much you’ll need after retirement. Think about the things you’d like to do after your retirement. Do you want to travel? Also think about where you want to live and how you want to live. You’ll need to save more if you want to retire in an expensive place like New York City. If you need help planning for retirement, look for an online calculator. SmartAsset’s retirement calculator can tell you how much you should save each month in order to reach your goals.
- A 401(k) is very useful for building retirement savings. The key to saving with a 401(k) is to start early and to contribute often. Small, regular contributions can easily add up to more than big contributions that you start making later in life. You should especially contribute to to a 401(k) if your employer offers a match. An employer match is basically free money to help you build savings.
- Another way to ensure you’re ready for retirement is to work with a financial advisor. According to industry experts, people who work with a financial advisor are twice as likely to be on track to meet their retirement goals. A matching tool like SmartAsset’s can help you find a person to work with to meet your needs. First you’ll answer a series of questions about your situation and goals. Then the program will narrow down your options from thousands of advisors to up to three registered investment advisors who suit your needs. You can then read their profiles to learn more about them, interview them on the phone or in person and choose who to work with in the future. This allows you to find a good fit while the program does much of the hard work for you.
Photo credit: ©iStock.com/Pears2295, ©iStock.com/ChristianChan, ©iStock.com/asiseeit