Knowing about what makes up a portfolio and its uses will help you build and manage your own.

What Is a Portfolio?

A portfolio is a broad term that can include any financial asset, like real estate or gold, but it is most often used to refer to the total of all your assets that earn income. An investor’s portfolio, also known as their “holdings,” can include any combination of stocks, bonds, cash and cash equivalents, commodities, and more. Some people and organizations manage their own investment portfolios, but there are other options. Many choose to hire a financial advisor or other financial professional to manage portfolios on their behalf.

How an Investment Portfolio Works

An investment portfolio can help you grow your wealth to achieve future goals such as a solid retirement fund. The basic premise is that you purchase investments, which increase in value, and as a result, you earn money.

Asset Allocation

The way you choose to invest in assets for your portfolio, or the types of assets you buy, is referred to as “asset allocation.” Assets fall mainly into three classes: equities (stocks), fixed income (bonds), and cash and cash equivalents (savings and money market accounts). Within each main category, you have a number of choices. For instance, equities include individual stocks, exchange-traded funds (ETFs), and managed mutual funds.

Diversification

To avoid being overly exposed to losses within a single company or industry, you can also choose to diversify your portfolio by buying among a number of investments across many asset classes.

Types of Portfolios

You may already have an investment portfolio in the form of a retirement account through your employer. Others may have portfolios in which they actively buy and sell assets with the goal of making a short-term profit. Some people invest for midterm goals, such as buying a home. Some have many portfolios designed to accomplish a range of goals. There are a handful of different types of investment portfolios. Each type relates to a specific investment goal or strategy, and to a level of comfort with risk.

Growth Portfolio

A growth portfolio, also known as an aggressive portfolio, involves taking on a greater level of financial risk in exchange for the chance of a greater return. Many growth investors seek out newer companies that need capital and have room to grow, rather than older and more stable companies with proven track records (and less room to grow). Investors in growth portfolios are willing to handle short-term fluctuations in the underlying value of their holdings if it means there is more potential for long-term capital gain. This type of portfolio is ideal if you have a high risk tolerance, or if you want to invest for the long-term.

Income Portfolio

An income portfolio is built with a focus on creating recurring passive income. Rather than seeking out investments that might result in the greatest long-term capital gain, investors look for investments that pay steady dividends with low risk to the underlying assets that earn those dividends. This type of portfolio is ideal if you are risk-averse, or if you plan to invest with a short to medium time horizon.

Value Portfolio

A value portfolio is made of up value stocks, or stocks that are priced low compared with the company’s overall financial picture. Value investors buy those underpriced stocks, then hold them as the price rises. Rather than focusing on income-generating stocks, investors with a value portfolio buy stocks to hold them for an extended period with the goal of long-term growth. This type of portfolio is ideal if you have a moderate risk tolerance and a long time horizon.

Defensive Portfolio

A defensive stock is one with relatively low volatility in an industry or sector that tends to remain mostly stable, in spite of changes in the broader market. In other words, defensive stocks represent those companies whose products are always in demand, no matter the state of the economy. A defensive portfolio is made up of low-volatility stocks with the intent to limit losses in a market downturn. Defensive portfolios often have lower risk and lower potential rewards. These portfolios work well for long time horizons, because they lead to smaller but sustained growth.

Balanced Portfolio

A balanced portfolio is one of the most common options investors use. The purpose of this type of portfolio is to reduce volatility. It mostly contains income-generating, moderate-growth stocks, as well as a large portion of bonds. The mix of stocks and bonds can help you to reduce risk no matter which way the market is moving. This type of portfolio is ideal for someone with a low to moderate risk tolerance and a mid- to long-range time horizon.

Do I Need an Investment Portfolio?

If you don’t currently have an investment portfolio, you might wonder if you actually need one. After all, isn’t the stock market risky? A 2020 Gallup poll found that only 55% of Americans report owning stock. This figure has been roughly the same for the past decade. The poll also found that if given an extra $1,000 to spend, about half of the people who took the survey (48%) thought it would be a bad idea to invest it in the market, while the other half (49%) thought it would be a good idea. Of course, there are many reasons why people might put off building a portfolio. They may need the money to pay for other things, like daily essentials. Or they may perceive the market as highly risky. They may even be wary of the learning curve that comes with investing. While these concerns are valid, starting your investment portfolio is one of the best ways to grow your wealth and reach major financial goals and milestones, especially a secure retirement.

Investment Portfolio vs. Savings Account

People often use the terms “saving” and “investing” interchangeably. For example, we might talk about saving for retirement in a 401(k), when we really mean investing for retirement. And while your savings account is technically a part of your overall portfolio, investing and saving are two very distinct strategies.

DIY portfolio management Using a robo advisor  Hiring a financial advisor or money manager

2. Think About Your Time Horizon

Your time horizon is the amount of time before you expect to need the money you invest. If you’re investing for a retirement that’s roughly 30 years away, your time horizon is 30 years. Experts generally recommend reducing your portfolio’s risk as your time horizon shrinks. For example, if you’re in your 20s and saving for retirement, you might have a growth portfolio that consists mainly of stocks. But as you near retirement age, you could adjust your portfolio to contain more low-risk investments, such as government bonds. Once you retire, you might opt for an income portfolio to preserve capital while creating income.

3. Identify Your Risk Tolerance

Everyone has a different appetite for risk. Some people might find the risk of investing exciting, while others want the security of knowing their money will be there when they need it. Your risk tolerance has a major impact on how you choose to build your portfolio. A more risk-averse investor might choose to stick with assets such as bonds and index funds. However, someone with a higher risk tolerance might explore real estate, individual stocks, and small-capitalization mutual funds.

4. Focus on Diversification

Diversifying your portfolio is an effective way of minimizing losses. This means if one asset performs poorly, it won’t impact your entire portfolio. You can diversify both between and within asset categories. For example, you could divide your money among stocks, bonds, real estate, and commodities—across asset categories. You could also diversify within a single asset class. In practice, that might mean you invest in an index fund that holds stocks across many industries to achieve a healthy mix.

5. Rebalance as Needed

Rebalancing is the process of adjusting your holdings to get back to your original asset allocation. Some of your investments will grow more than others, meaning they’ll begin to take up a larger portion of your portfolio. To maintain your desired asset allocation, you may need to sell some assets (those in which you’ve seen growth) and buy more of other types of assets (those that haven’t had the same level of growth or have decreased in value).