Designing an investment portfolio involves creating a policy to fit your needs based on various factors (investment goals, risk tolerance, and time horizon), choosing investments that match your policy, and implementing the design.
We begin by asking you some basic investment questions. For example, why are you investing? Perhaps you would like to buy a house, or maybe you want to retire early. Next, we need to know how comfortable you are with investing. Are you a cautious investor, or are you willing to take risks? Then, we take into account your time horizon for investing. Are you saving for your toddler's college education or to retire in a few years? Finally, we determine what types of investments will best help us work toward your goals. In other words, what is the proper asset allocation for your particular situation? Your answers to these questions can be a starting point for constructing an investment policy and mapping out a portfolio design.
Once we've determined your financial goals and how your time horizon, risk tolerance, and liquidity needs affect them, it's time to think about how your investments might help you achieve those goals. When considering any investment, we think about what it offers in terms of three key investment goals:
Growth: In investing terms, growth (also known as capital appreciation) is an increase in the value of an investment; in other words, you can sell it for more than you paid for it. Your capital is the money you put into an investment initially. If you buy a stock that costs $10 a share and eventually sell the stock for $12 a share, that extra $2 represents capital appreciation, or growth.
Income: Some investments make periodic payments of interest or dividends. Those payments represent investment income, which can be spent or reinvested. For retirees, income obviously is a key investment goal, but it can be important for other reasons as well. For example, income payments can help offset the impact of the ups and downs of a growth-oriented investment.
Stability: This is sometimes known as capital preservation or protection of principal. An investment that focuses on stability concentrates less on increasing the value of that investment and more on trying to ensure that it doesn't lose value. If you plan to spend a certain amount of money soon and want to make sure the money is there when you need it, stability might be your primary investment goal.
With each individual investment, there is a relationship between growth, income, and stability. The more an investment offers in one of those areas, the more you may have to trade off in terms of the other two. The key to setting investment goals is to tailor each investment to what you want it to do for you. You may choose to have a single investment goal for a given financial goal, as in the example of making stability a priority for short-term money. Or you may prefer to combine several investments to achieve a balance among stability, income, and growth so that you maximize your overall returns at a level of risk that you're comfortable with and that suits your financial goal.
Once we have settled on a policy that reflects your attitudes about investing and a portfolio design that will help you pursue your goals, the next step is managing your investments. This is the subsequent selection of investments (the actual buying and selling) in keeping with the overall portfolio design.
Managing a portfolio is one of the most important steps in the investment process. Properly managing an investment portfolio requires knowing not only what investments to purchase, but also when to buy and sell them. In addition, managing a portfolio requires constant monitoring of performance, along with rebalancing and making adjustments as needed.