- Investment Portfolio: What It Is and How to Build a Good One
- Investment portfolio definition
- Investment portfolios and risk tolerance
- 1. Decide how much help you want
- 2. Choose an account that works toward your goals
- 3. Choose your investments your risk tolerance
- Mutual funds
- 4. Determine the best asset allocation for you
- 5. Rebalance your investment portfolio as needed
- Guide to diversification
- 1. Create a tailored investment plan
- 2. Invest at an appropriate level of risk
- 3. Manage your plan
Investment Portfolio: What It Is and How to Build a Good One
any industry, investing has its own language. And one term people often use is “investment portfolio,” which refers to all of your invested assets.
Building an investment portfolio might seem intimidating, but there are steps you can take to make the process painless. No matter how engaged you want to be with your investment portfolio, there’s an option for you.
Investment portfolio definition
An investment portfolio is a collection of assets and can include investments stocks, bonds, mutual funds and exchange-traded funds. An investment portfolio is more of a concept than a physical space, especially in the age of digital investing, but it can be helpful to think of all your assets under one metaphorical roof.
For example, if you have a 401(k), an individual retirement account and a taxable brokerage account, you should look at those accounts collectively when deciding how to invest them.
If you’re interested in being completely hands-off with your portfolio, you can outsource the task to a robo-advisor or financial advisor who will manage your assets for you. (Learn more about working with a financial advisor.)
|NerdWallet rating NerdWallet's ratings are determined by our editorial team. The scoring formula for online brokers and robo-advisors takes into account over 15 factors, including account fees and minimums, investment choices, customer support and mobile app capabilities.||NerdWallet rating NerdWallet's ratings are determined by our editorial team. The scoring formula for online brokers and robo-advisors takes into account over 15 factors, including account fees and minimums, investment choices, customer support and mobile app capabilities.||NerdWallet rating NerdWallet's ratings are determined by our editorial team. The scoring formula for online brokers and robo-advisors takes into account over 15 factors, including account fees and minimums, investment choices, customer support and mobile app capabilities.|
Investment portfolios and risk tolerance
One of the most important things to consider when creating a portfolio is your personal risk tolerance. Your risk tolerance is your ability to accept investment losses in exchange for the possibility of earning higher investment returns.
Your risk tolerance is tied not only to how much time you have before your financial goal such as retirement, but also to how you mentally handle watching the market rise and fall.
If your goal is many years away, you have more time to ride out those highs and lows, which will let you take advantage of the market’s general upward progression.
Use our calculator below to help determine your risk tolerance before you start building your investment portfolio.
1. Decide how much help you want
If building an investment portfolio from scratch sounds a chore, you can still invest and manage your money without taking the DIY route. Robo-advisors are an inexpensive alternative. They take your risk tolerance and overall goals into account and build and manage an investment portfolio for you.
» Need help investing? Learn about robo-advisors
If you want more than just investment management, an online financial planning service or a financial advisor can help you build your portfolio and map out a comprehensive financial plan.
2. Choose an account that works toward your goals
To build an investment portfolio, you’ll need an investment account.
There are several different types of investment accounts. Some, IRAs, are meant for retirement and offer tax advantages for the money you invest. Regular taxable brokerage accounts are better for nonretirement goals, a down payment on a house.
If you need money you’re planning on investing within the next five years, it may be better suited to a high-yield savings account. Consider what exactly it is you're investing for before you choose an account.
You can open an IRA or brokerage account at an online broker — you can see some of our top picks for IRAs.
3. Choose your investments your risk tolerance
After opening an investment account, you’ll need to fill your portfolio with the actual assets you want to invest in. Here are some common types of investments.
Stocks are a tiny slice of ownership in a company. Investors buy stocks that they believe will go up in value over time. The risk, of course, is that the stock might not go up at all, or that it might even lose value.
To help mitigate that risk, many investors invest in stocks through funds — such as index funds, mutual funds or ETFs — that hold a collection of stocks from a wide variety of companies.
If you do opt for individual stocks, it’s usually wise to allocate only 5% to 10% of your portfolio to them. Learn about how to buy stocks.
Bonds are loans to companies or governments that get paid back over time with interest. Bonds are considered to be safer investments than stocks, but they generally have lower returns.
Since you know how much you’ll receive in interest when you invest in bonds, they’re referred to as fixed-income investments.
This fixed rate of return for bonds can balance out the riskier investments, such as stocks, within an investor’s portfolio. Learn how to buy bonds.
There are a few different kinds of mutual funds you can invest in, but their general advantage over buying individual stocks is that they allow you to add instant diversification to your portfolio.
Mutual funds allow you to invest in a basket of securities, made up of investments such as stocks or bonds, all at once. Mutual funds do have some degree of risk, but they are generally less risky than individual stocks.
Some mutual funds are actively managed, but those tend to have higher fees and they don’t often deliver better returns than passively managed funds, which are commonly known as index funds.
Index funds and ETFs try to match the performance of a certain market index, such as the S&P 500.
Because they don't require a fund manager to actively choose the fund's investments, these vehicles tend to have lower fees than actively managed funds.
The main difference between ETFs and index funds is that ETFs can be actively traded on an exchange throughout the trading day individual stocks, while index funds can only be bought and sold for the price set at the end of the trading day.
While you may think of other things as investments (your home, cars or art, for example), those typically aren’t considered part of an investment portfolio.
4. Determine the best asset allocation for you
So you know you want to invest in mostly funds, some bonds and a few individual stocks, but how do you decide exactly how much of each asset class you need? The way you split up your portfolio among different types of assets is called your asset allocation, and it’s highly dependent on your risk tolerance.
You may have heard recommendations about how much money to allocate to stocks versus bonds. Commonly cited rules of thumb suggest subtracting your age from 100 or 110 to determine what portion of your portfolio should be dedicated to stock investments.
For example, if you’re 30, these rules suggest 70% to 80% of your portfolio allocated to stocks, leaving 20% to 30% of your portfolio for bond investments. In your 60s, that mix shifts to 50% to 60% allocated to stocks and 40% to 50% allocated to bonds.
» Read more: Simple portfolios to get you to your retirement goals
When you’re creating a portfolio from scratch, it can be helpful to look at model portfolios to give you a framework for how you might want to allocate your own assets. Take a look at the examples below to get a sense of how aggressive, moderate and conservative portfolios can be constructed.
A model portfolio doesn’t necessarily make it the right portfolio for you. Carefully consider your risk tolerance when deciding on how you want to allocate your assets.
5. Rebalance your investment portfolio as needed
Over time, your chosen asset allocation may get whack. If one of your stocks rises in value, it may disrupt the proportions of your portfolio. Rebalancing is how you restore your investment portfolio to its original makeup.
(If you’re using a robo-advisor you probably won’t need to worry about this, as the advisor will ly automatically rebalance your portfolio as needed.
) Some investments can even rebalance themselves, such as target-date funds, a type of mutual fund that automatically rebalances over time.
Some advisors recommend rebalancing at set intervals, such as every six or 12 months, or when the allocation of one of your asset classes (such as stocks) shifts by more than a predetermined percentage, such as 5%. For example, if you had an investment portfolio with 60% stocks and it increased to 65%, you may want to sell some of your stocks or invest in other asset classes until your stock allocation is back at 60%.
Guide to diversification
- Diversification can help manage risk.
- You may avoid costly mistakes by adopting a risk level you can live with.
- Rebalancing is a key to maintaining risk levels over time.
It's easy to find people with investing ideas—talking heads on TV, or a “tip” from your neighbor.
But these ideas aren't a replacement for a real investment strategy that can help you achieve your goals no matter what surprises the market serves up.
We believe that you should have a diversified mix of stocks, bonds, and other investments, and should diversify your portfolio within those different types of investment. Setting and maintaining your strategic asset allocation are among the most important ingredients in your long-term investment success.
Then give your portfolio a regular checkup. At the very least, you should check your asset allocation once a year or any time your financial circumstances change significantly—for instance, if you lose your job or get a big bonus. Your checkup is a good time to determine if you need to rebalance your asset mix or reconsider some of your specific investments.
The goal of diversification is not necessarily to boost performance—it won't ensure gains or guarantee against losses. Diversification does, however, have the potential to improve returns for whatever level of risk you choose to target.
To build a diversified portfolio, you should look for investments—stocks, bonds, cash, or others—whose returns haven't historically moved in the same direction and to the same degree. This way, even if a portion of your portfolio is declining, the rest of your portfolio is more ly to be growing, or at least not declining as much.
Another important aspect of building a well-diversified portfolio is trying to stay diversified within each type of investment.
Within your individual stock holdings, beware of overconcentration in a single investment. For example, you may not want one stock to make up more than 5% of your stock portfolio.
Fidelity also believes it’s smart to diversify across stocks by market capitalization (small, mid, and large caps), sectors, and geography.
Again, not all caps, sectors, and regions have prospered at the same time, or to the same degree, so you may be able to reduce portfolio risk by spreading your assets across different parts of the stock market. You may want to consider a mix of styles too, such as growth and value.
When it comes to your bond investments, consider varying maturities, credit qualities, and durations, which measure sensitivity to interest-rate changes.
During the 2008–2009 bear market, many different types of investments lost value at the same time, but diversification still helped contain overall portfolio losses.
Consider the performance of 3 hypothetical portfolios: a diversified portfolio of 70% stocks, 25% bonds, and 5% short-term investments; an all-stock portfolio; and an all-cash portfolio.
As you can see in the table below,1 a diversified portfolio lost less than an all-stock portfolio in the downturn, and while it trailed in the subsequent recovery, it easily outpaced cash and captured much of the market's gains.
A diversified approach helped to manage risk, while maintaining exposure to market growth.
Source: Strategic Advisers, Inc.
Hypothetical value of assets held in untaxed accounts of $100,000 in an all-cash portfolio; a diversified growth portfolio of 49% US stocks, 21% international stocks, 25% bonds, and 5% short-term investments; and all-stock portfolio of 70% US stocks and 30% international stocks. This chart’s hypothetical illustration uses historical monthly performance from January 2008 through February 2014 from Morningstar/Ibbotson Associates; stocks are represented by the S&P 500 and MSCI EAFE Indexes, bonds are represented by the Barclays US Intermediate Government Treasury Bond Index, and short-term investments are represented by US 30-day T-bills. Chart is for illustrative purposes only and is not indicative of any investment. Past performance is no guarantee of future results.
Why is it so important to have a risk level you can live with? The value of a diversified portfolio usually manifests itself over time.
Unfortunately, many investors struggle to fully realize the benefits of their investment strategy because in buoyant markets, people tend to chase performance and purchase higher-risk investments; and in a market downturn, they tend to flock to lower-risk investment options; behaviors which can lead to missed opportunities. The degree of underperformance by individual investors has often been the worst during bear markets.
“Being disciplined as an investor isn't always easy, but over time it has demonstrated the ability to generate wealth, while market timing has proven to be a costly exercise for many investors,” observes Ann Dowd, CFP®, vice president at Fidelity Investments. “Having a plan that includes appropriate asset allocation and regular rebalancing can help investors overcome this challenge.”
To start, you need to make sure your asset mix (e.g., stocks, bonds, and short-term investments) is aligned to your investment time frame, financial needs, and comfort with volatility. The sample asset mixes below combine various amounts of stock, bond, and short-term investments to illustrate different levels of risk and return potential.
Data source: Fidelity Investments and Morningstar Inc, 2021 (1926-2020). Past performance is no guarantee of future results. Returns include the reinvestment of dividends and other earnings. This chart is for illustrative purposes only.
It is not possible to invest directly in an index. Time periods for best and worst returns are calendar year. For information on the indexes used to construct this table, see Data Source in the notes below.
The purpose of the target asset mixes is to show how target asset mixes may be created with different risk and return characteristics to help meet an investor’s goals. You should choose your own investments your particular objectives and situation.
Be sure to review your decisions periodically to make sure they are still consistent with your goals.
Once you have a target mix, you need to keep it on track with periodic checkups and rebalancing. If you don't rebalance, a good run in stocks could leave your portfolio with a risk level that is inconsistent with your goal and strategy.
What if you don't rebalance? The hypothetical portfolio shows what would have happened if you didn’t rebalance a portfolio from 2006–2019: The stock allocation would have grown dramatically (see chart).
This chart's hypothetical illustration uses historical monthly performance from January 1997 through December 2018 from Morningstar/Ibbotson Associates; stocks are represented by the S&P 500 and MSCI EAFE Indexes, bonds are represented by Barclays US Intermediate Government Treasury Bond Index, and short-term investments are represented by US 30-day T-bills. Chart is for illustrative purposes only and is not indicative of any investment. Past performance is no guarantee of future results.
The resulting increased weight in stocks meant the portfolio had more potential risk at the end of 2019. Why? Because while past performance does not guarantee future results, stocks have historically had larger price swings than bonds or cash. This means that when a portfolio skews toward stocks, it has the potential for bigger ups and downs.2
Rebalancing is not just a volatility-reducing exercise. The goal is to reset your asset mix to bring it back to an appropriate risk level for you. Sometimes that means reducing risk by increasing the portion of a portfolio in more conservative options, but other times it means adding more risk to get back to your target mix.
Investing is an ongoing process that requires regular attention and adjustment. Here are 3 steps you can take to keep your investments working for you:
1. Create a tailored investment plan
If you haven't already done so, define your goals and time frame, and take stock of your capacity and tolerance for risk.
2. Invest at an appropriate level of risk
Choose a mix of stocks, bonds, and short-term investments that you consider appropriate for your investing goals and don’t forget to consider stock awards you may have through your employer. (Fidelity's Planning & Guidance Center can help.)
Stocks have historically had higher potential for growth, but more volatility. So if you have time to ride out the ups and downs of the market, you may want to consider investing a larger proportion of your portfolio in equities.
On the other hand, if you'll need the money in just a few years—or if the prospect of losing money makes you too nervous—consider a higher allocation to generally less volatile investments such as bonds and short-term investments. By doing this, of course, you'd be trading the potential of higher returns for the potential of lower volatility.
Once you have chosen an asset mix, research and select appropriate investments.
3. Manage your plan
We suggest you—on your own or in partnership with your financial advisor—do regular maintenance for your portfolio. That means:
- Monitor– Evaluate your investments periodically for changes in strategy, relative performance, and risk.
- Rebalance – Revisit your investment mix to maintain the risk level you are comfortable with and correct drift that may happen as a result of market performance. There are many different ways to rebalance; for example, you may want to consider rebalancing if any part of your asset mix moves away from your target by more than 10 percentage points.
- Refresh – At least once a year, or whenever your financial circumstances or goals change, revisit your plan to make sure it still makes sense.
Achieving your long-term goals requires balancing risk and reward. Choosing the right mix of investments and then periodically rebalancing and monitoring your choices can make a big difference in your outcome.