An effective and well-balanced investment portfolio is the backbone of an individual’s financial planning. Not only for a big investor but for every individual financial planning is very important in order to achieve one’s life goals. And an investment portfolio which is exclusively designed for the individual according to the cash flow and risk-taking capability of the individual to fulfill the financial needs and to achieve financial goals with minimum risk is a very complex process. However by following certain investment strategies and with a well structured and adaptive asset allocation every investor can make a portfolio which is aligned to their individual investment goals.
We listed the most important aspect every investor should work on in order to make a very effective and profitable investment portfolio
Calculating Risk taking capacity: The first thing every investor should do before investing and start making investment portfolio is to calculate the risk-taking capacity. Every individual is different and everyone has different risk taking capacity. The first aspect an investor has to think on is the risk factor of investment as all the investment options out there have certain risk associated with it and every investor has a different risk-taking capability. And it is an old saying that Higher the risk higher the return but by calculating the risk an investor can take we can also play with it and make the return even higher with keeping risk in check.
The first step in portfolio making starts with calculating the investors risk taking capacity. To calculate risk we have to take into account various factors like age of investor, income and there sources average life expectancy and financial obligation in different stages of life. It is not a simple thing which can be calculated only with the age of investor as all the other investor advisers out there promotes.
Age is not the only factor which can calculate the risk-taking capacity of an investor as various other factors is also there which can affect it. Here we had listed few aspects of risk which should be considered in assessing the risk-taking capacity of an individual.
Financial obligations: In today’s credit savvy world we all have few outstanding liabilities and If an investor has some outstanding unsecured loan then that liability will not only decrease the amount of savings and investment but also it will decrease the level of risk tolerance.
Individual personality: If an investor can’t able to deal with a short-term fall in portfolio and he starts to panic and cant able to sleep then it is obvious that he has a very low-risk tolerance and he cannot expect higher returns as he cannot take a considerable amount of risk in order to gain money.
Income to saving rate: It is a very important factor which helps big time in calculating risk taking capacity as it indicates the excess cash flow or income which an investor is saving and can save in coming future. This amount of savings can be invested in the markets and higher the income to saving rate higher the risk-taking capacity because it indicates that the cash inflow of an individual is higher from the outflow and after settling all the liabilities and expenses investor have some money which he can invest and the higher the amount of savings one have the higher he can take risk.
Investment duration, Age, and liquidity needs: Investment duration plays a very big role in investment and in that part the age factor comes in the picture as every investment requires time. More time you give to the investment more return you can expect from your portfolio. That is the reason most long-term portfolios work better than the short-term ones.
So in order to calculate the risk-taking capacity an investor have to analyze the investment duration and mostly that can be calculated by looking in the retirement time of an investor as if the retirement is close then it is obvious that the investor has to use their investment after retirement and that will result in a decrease in investment duration and it also decreases the risk-taking capacity as with a higher investment duration in a risky asset an investor can achieve the average historic return from the market and also it can decrease the short-term uncertainties in the markets with the help of cost averaging, time value and market growth.
Selecting the most suitable Asset Allocation mix according to the risk profile: According to the risk-taking capacity, every investor can be divided into three categories the first category is Conservative investor second is a Moderate risk taker and third is an Aggressive Investor. After looking all the factors we had listed above to help an investor to calculate the risk-taking capacity investor can easily know in which category he or she falls in and according to the category we can select the perfect Asset mix which can give a good return with the predetermined risk.
If an investor falls under the aggressive investor category the ideal asset mix would focus more on equities and less in debt instruments like bonds and fixed income securities. And for a conservative investor, the situation will be totally opposite as the asset mix will be more in fixed income securities and bonds and less in the risky investment like equities. As the goal of investment in both the profile is different from each other the aggressive investor will focus on higher return and he also can tolerate higher risk. On the other hand, a conservative investor’s focus will be more on the protection of investment with the cost of a slow-moving profit. While a moderate investor is the one who can take the calculated risk and he’s investment goal of high risk with decent capital protection makes his profile perfect for a 50-50 asset mix of equities and fixed income and bond investment.
Building the portfolio according to the asset mix: Once you are done with the risk profiling and you had determined the right asset mix suitable for your profile the next step is to build the investment portfolio according to the selected asset mix.
There are three types of asset class available in the market one is equities second is debt instruments like bonds and fixed income instruments and third is cash and cash equivalents. But these asset classes can be divided into sub classes which have their own unique risk and return ratios.
As we all know that all stocks and bonds do not perform the same and we have to be very cautious while selecting the perfect stock or bond to invest in and while making the portfolio every investor should study and select the stocks and bond very carefully to fulfill the asset mix
Building the equity part of asset mix: selecting the right stock which will fit in your risk and reward strategy selected for the equity part of your portfolio is a very important process which includes the selection of sector and stocks by in-depth study of the stock and adding those selected stocks to your portfolio on the cheapest cost. This process requires lots of work, study and efforts as an investor have to look into the market and then have to add the stocks to the portfolio. Or an investor can also select a mutual fund which will fit on the risk-reward ratio but he has to pay some charges for it which will slightly affect the profit.
Selection of debt instrument: the most popular debt investment instrument is bond and selection of a bond which satisfies your requirement for your portfolio is also a very important process as there are various factors which an investor have to study before investing in any bond like type and ratings of bond, maturity date etc. so before adding any bond on the portfolio an investor has to think about those factors.
While building both equity and bond portfolio keeping the investment expense low is very important as it will decrease the cost of investment and thus increase the profits. And for that investor always has to select a broker how to offer the best rates and also select the securities which will give tax advantages.
Reevaluating and rebalancing the portfolio: As we all know that the financial market is dynamic and it keeps on changing. Market movement and market scenario can affect some sectors and securities much more than other securities. In order to maintain and increase the efficiency and performance of your portfolio, we have to re-evaluate the assets and make the necessary maintenance changes in the portfolio which can increase the performance of the investment portfolio.
According to the market condition and movement, every investor has to adjust the investment portfolio which can make most out of the market situation and which can keep up with the changes or the risk tolerance of the investor as with time the risk-taking capacity of an investor can also change.
However, the rebalancing can be done only within the scope of the asset allocation strategy unless there is any big difference in the risk-taking capacity of the investor then only the asset mix will change otherwise the rebalancing will be done within the allocated space.
The bottom line: Making an effective portfolio according to your risk profile is a very complex task, it requires lots of efforts and study to build and maintain a good performing portfolio. But to achieve financial goals a well diversified and well-managed portfolio which is exclusively designed according to the risk-taking capacity of the investor is very important. To keep the performance of the portfolio up to the mark and to keep it intact maintains and making timely changes according to the market condition is necessary it enables the investor to achieve capital appreciation and constant growth goal.
Control Costs By Keeping Investment Expenses Low: Every dollar you give up in fees, brokerage commissions, sales loads, and mutual fund expense ratio charges is a dollar that can’t compound for you. What seems like a small amount of money every year can end up costing you hundreds of thousands, or even millions, of dollars in lost wealth that you can never recover; money that went straight into the pocket of big banks, Wall Street, and executives.
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