Portfolio construction is a disciplined, personalized process. It is the process of blending together the broad classes so as to obtain return with minimum risk. In constructing a portfolio, the individual risk and return characteristics of the underlying investments must be considered along with your unique needs, goals and risk considerations.
Many investors have built collections of funds over their investing lifetime. As markets have developed and investing styles come in and out of fashion, it is likely that the total portfolio may be too heavily invested in a particular asset class (e.g. equities), region (e.g. Australia), sector (e.g. technology) or even a particular share which is present in every fund but to varying degrees. In other words, your combined portfolio may no longer meet your needs or aspirations.
What to expect
Building a portfolio involves understanding the way various types of investments work, and combining them to address your personal investment objectives and factors such as attitude to risk the investment and the expected life of the investment.
To help in choosing a suitable asset allocation we have created a Risk Profiler that helps identify your attitude to risk and therefore better identify a combination of investments to build a portfolio.
Benefits of having an investment portfolio
An investor needs to allocate capital in a prudent way in order to reap the benefits of having exposure to the financial markets. Diversification into multiple asset classes will help to protect an investor’s capital in the event that one segment of the financial markets does not perform well.
Ability to Hedge
Diversification can enable a portfolio to grow both when markets boom and returns crumble in one sector. Diversification gives an investor the chance to achieve positive returns in one market when another market is generating negative returns.
An investor who chooses to direct capital into the financial markets as opposed to other investment choices, such as real estate, is likely to be able to access that money in a timely manner when needed.
Capital preservation allows you to protect the capital you have, rather than focusing on the rate of return for your investments. Diversification makes it much easier for an investor to protect their capital, allocating money to different investments. Your capital can be protected from the wild swings of the market, while achieving long-term growth at the same time.
By building an investment portfolio that focuses on income securities, an investor can supplement his income for the near term and in the future. As a result, an investor can exchange the investment for cash rather quickly. Investing in tangible assets, such as real estate, is a longer-term commitment that generally cannot easily and quickly be converted to cash.
Placing money in a bank savings account may protect money, but growth is likely to be highly modest in comparison with the potential profits in the financial markets. By having an investment portfolio, an investor can not only invest to guard his capital but also position the portfolio to potentially earn sizable profits so that he is prepared for events such as funding a college education or retirement.
Determinants of Portfolio Performance
- Asset Allocation (93.6%)
- Market Timing (1.7%)
- Security Selection (2.5%)
- Other Factors (2.2%)
Source: “Determinants of Portfolio Performance” by Gray P.Brinson, L. Randolph Hood, and Gilbert L. Beebower, Financial Analysts Journal, July-August 1986.
Key considerations for building your portfolio
You need to consider your goals and the money that you will need to achieve these. This will help determine the asset allocation you choose. We will examine the major asset classes later in this guide.
How soon you intend to start taking money from your portfolio may influence the type of investments you choose. For example, if you need to withdraw money relatively soon, you may consider having a higher percentage of your investments in cash.
Balancing the risk you are willing to accept with the investment returns you need or want will help determine your asset allocation. Your financial adviser can make sure you understand the risks associated with investing in each asset class.