An investment portfolio is a set of financial products with a strategic asset allocation of each of them. A smart investor takes a diligent and disciplined approach to invest their money in financial assets that minimize their risk and reward them with good returns.
Portfolio investments may include a wide range of financial assets like stocks, futures, and options, derivatives, Real Estate Investment Trusts (REITs), mutual funds, government bonds, Exchange-Traded Funds (ETFs), corporate bonds, physical instruments like gold, commodities, rental properties, etc.
An investor should not invest in too many assets and should keep a few crucial factors in mind before creating their portfolio.
Factors Determining Asset Allocation in a Portfolio
**Investor’s risk tolerance: **This is the level of uncertainty (in terms of returns) that one can handle while investing in a particular asset. Those with a lower tolerance for risk should invest in less volatile products like government bonds and mutual funds, while those with a higher tolerance for risk should allocate their funds in real estate, equity market, etc.
Investor’s age: This plays an essential role in deciding fund allocation in different assets. Young investors (those in the age bracket of 25 to 35 years) may have a higher allocation rate in equity, whereas those who are nearing their retirement can have higher asset allocation in safer instruments like debts and bonds.
Amount to invest: It is the surplus money available to an investor for a portfolio investment. Generally, younger investors in the early stages of their careers have a smaller amount available to create a portfolio as compared to those who have been earning for many years.
Investment horizon: It is the time period for which the investor will stay invested in a particular financial product. For a longer investment horizon (say, 30 years), investing in riskier assets like equities may give good returns, whereas, for a shorter horizon, fixed income assets like government bonds are a better choice.
As a rule of thumb, the higher the risk in an investment is, the higher the expected returns will be from it and vice versa. Thus, it is necessary to implement strategic asset allocation in those financial assets which help the investor optimize the risk and reward in his investment portfolio.
The investors can allocate their assets strategically with the help of a diversified portfolio.
Going by traditional wisdom, an investor should not put all their eggs in one basket, i.e., they should not invest in only one financial product or asset class as there’s a risk of financial losses in case that one asset class or product does not perform well. But investing only in safe assets like government bonds, PPFs, NSCs, etc. is not the best option either as these investments will give limited returns. Thus, investors should include some high growth-oriented assets like equities as well in their portfolio to manage risks and returns together.
A diversified portfolio with strategic asset allocation in different asset classes will ensure good returns with a reasonable level of risk.
Here are a few common strategies to diversify your investment portfolio:
The Aggressive Investment Strategy
It is primarily a stock portfolio that will have significant asset allocation in stocks with very little investment in bonds or cash. It is created with the objective of getting maximum returns by taking a high degree of risk. The investor needs a high tolerance for risk and a long investment horizon to get good returns from this strategy.
The Moderate Risk Investment Strategy
It is a stock portfolio that will mainly invest in stocks that give stable returns with consistent dividends, irrespective of the volatility in the overall equity market. These stocks provide an extra level of protection against market fluctuations while offering moderate returns. Investors with moderate risk tolerance and a long investment horizon can consider portfolio investment using this strategy.