Career Advice - A Community Blog

Erik Larson writes about the job market, resume improvement, and career advice

Steps to Building a Profitable Portfolio

Written by Erik Larson, Community Blogger | Mar 10, 2017 1:54 AM
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The dynamism of the business environment is growing with each passing day, and the financial marketplace is not an exception. In this field of business, the success of an investor is largely dependent on the ability to have a well-calculated and maintained portfolio. Every investor must aspire to develop a portfolio where there is a balance between risks and rewards. The four key factors to developing a successful portfolio include the ability to measure return on investment, measure risks, diversify, and most importantly, know how to avoid the lottery effect. 

The right portfolio should be able to meet your future needs for capital and also give you enough peace of mind. A systematic approach should be used in the construction of portfolios to ensure that it conforms to your goals and investment strategies. Consider the following essential steps:

Identify an appropriate asset allocation 

The very first step entails determining your financial position - an exercise guided by factors such as income and expenses, investments, as well as personal investment goals. Other important factors to consider include age, personality, risk tolerance, and investment style. When determining your risk tolerance, don't be so quick to dismiss risks completely, just because you intend to optimize your needs. Keep in mind the risk/return trade-off principle where greater returns are associated with greater risk of losses. 

Age is also a big determinant when it comes to the level of risk someone is willing to take. For instance, individuals aged between 25 and 35 are almost always aggressive investors, and great risk takers - perhaps because they have the luxury of time. Their portfolio mostly contains equities. People between 35 and 50 years tend to concentrate on building savings, and their decisions are centered on establishing a moderately aggressive portfolio made up of an equal measure of equities and debts. Investors aged above 50 tend to avoid risky investments as they move towards ensuring a stable financial life. They love investments that promise fixed returns and regular streams of income. 

Actual asset allocation 

The next step involves allocating the capital to the various instruments. Familiarize yourself with all the instruments that the market has to offer, and there are two types namely equities and debt. Equities are the riskiest, yet the most rewarding instruments. Besides being the safest, bonds are also appealing because they provide regular streams of income. Mutual funds are professionally managed fund houses where investment firms focus on equities and bonds. 

The investors' love for fund houses emanates from the fact that they track the market on a regular basis, and the funds are handled by finance and investment experts. The banks avail various debt options in the form of recurring deposits, fixed deposits, as well as savings accounts. Prudence dictates that you calculate the risk involved in the investments. Also, keep in mind the importance of having a diversified portfolio. 

Measure the return on investment 

Measuring the returns on the capital provides a practical way of determining whether asset allocation has been done correctly. Here is the formula for calculating ROI:

Return on investment = (Current price-Cost price)÷cost price

Reassigning portfolio weightings 

Periodic analysis and rebalancing of the portfolio is imperative because of the dynamic nature of the market. In many instances, fluctuations in the market may demand a change in the initial composition of the portfolio. Changes in the factors you considered when determining asset allocation such as age, the most recent financial position, and financial goals may also warrant a revision of the portfolio. Investors' risk tolerance also changes requiring a reevaluation of the first portfolio. Categorize the investments quantitatively and establish their values with the whole portfolio in mind. 

Aspire to have a sufficiently diversified portfolio to increase your chances of enjoying a consistent investment growth even in the long term. Closely track your portfolio, while ensuring to make the necessary changes when there is a need to do so. 
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