Building an investment portfolio is a personal decision, and there is no one-size-fits-all strategy. With that in mind, here are three important factors to consider when building your portfolio.
What is your risk tolerance?
Risk tolerance is the degree of variability in investment returns that you are willing to withstand. Let’s face it. Most of the higher performing asset classes like stocks have a higher degree of volatility and uncertainty.
If you are risk-averse, then you should put a lower percentage of your investments in stocks and more in low-risk assets with slow but stable returns. This allows you to sleep easy as these low-risk investments are less likely to go through huge drawdowns.
However, if you are like me, willing to ride the short-term volatility of these high-risk asset classes, then, by all means, put a higher percentage of your portfolio in them. These assets are the ones that will boost your returns over the long-term and can help you achieve your financial goals faster.
To find out what is your risk tolerance, you can take simple risk tolerance tests online.
What is your monthly expenditure?
Every investor needs to have an emergency fund set aside in case of exigencies. Ideally, your emergency fund should be around six to 12 months of your monthly expenditure. This fund will come in useful if you lose your job or have medical bills to pay. By setting this money aside, you can pay off your dues without dipping into your investment portfolio, which ideally should be left to grow for the long-term.
As a rule of thumb, you should add monthly mortgage payments, all daily expenditures and the occasional holiday expenses into the equation to get a good estimate of how much you should set aside. If you have a family or are caring for your parents, then your emergency fund needs to increase accordingly.
How good is your financial knowledge?
The third factor is that we should invest only in assets that we understand. For example, only investors who have the know-how should attempt to invest in individual stocks and bonds. Studies have shown that despite the upward nature of stocks, the majority of retail investors end up trailing the market as a whole. If you simply invest in stocks, without the sufficient knowledge, you may end up adding to that statistic.
Therefore, to curb investment losses, we should either attempt to educate ourselves on stock picking or make use of other investment vehicles that we are more familiar with. Even if we want to invest in unit trusts and let the fund manager manage our money, we should educate ourselves about unit trusts so that we can choose the one that suits our individual goals.
The Foolish bottom line
Before you begin your investment journey and decide on how you wish to build your portfolio, it is important you ask yourself these three simple questions. Your answers to these will determine which assets you should invest in and how much to start with.
3 Questions to Ask When Building Your Investment Portfolio
Here are three questions to ask before building your investment portfolio.