How To Create A Stock Portfolio: A Beginner’s Guide To Creating A Portfolio In 6 Steps
If you've ever researched stock market investing, you've likely heard the term “stock portfolio.”
You’ve also likely heard that owning a portfolio of different stocks is a smart idea because diversifying your investments reduces your risk. And yet, what might not be so clear to you is how to create a stock portfolio and diversify it properly.
That's precisely why we’re here.
We’ll explain stock portfolios and cover everything you need to know about creating your own, including risk tolerance, portfolio types are and more.
What Is A Stock Portfolio?
A stock portfolio is a selection of stocks and other assets that you have invested money in.
We specifically say “and other assets” because your stock portfolio can include a range of other investments, such as bonds, commodities and financial securities.
As a result, the more correct term is typically “investment portfolio.” However, both terms are often used interchangeably.
Why Risk Tolerance Analysis Is Key For A Successful Portfolio
Stock or investment portfolios can be incredibly diverse in terms of the assets they include and the proportion of those assets relative to the portfolio’s structure.
The exact composition of your portfolio and its purpose will ultimately depend on one of the most fundamental elements of investing — risk tolerance.
Investing in financial assets always involves some degree of risk. The question is never whether investing is risky, rather, how much risk you’re willing to take — which is the definition of risk tolerance.
Risk tolerance is the degree of risk you as an investor are ready to take when setting your investment goals. As a general rule in investing, the higher the risk, the higher the profit potential of your investments.
Risk tolerance analysis is essential to building a successful investment portfolio, with the efficient frontier being the key element of this analysis.
The efficient frontier is a theoretical point on the risk-return spectrum where the expected return is maximized for a given risk level.
In other words, a stock portfolio that lies on the efficient frontier will deliver you the most value for the risk you’re willing to take.
A portfolio that sits well below the frontier will not reach its full profitability potential relative to its riskiness, while a portfolio above the frontier might be too risky to justify the profits you can expect from it.
As a result, the purpose of risk tolerance and efficient frontier analysis is to help you create a portfolio that offers the most bang for your buck, while minimizing the chances of losing your money.
3 Main Types Of Stock Portfolios
There is no such thing as a one-size-fits-all approach to building a stock portfolio.
Nevertheless, your stock portfolio will most likely fall under one of the few portfolio types that are differentiated by — you guessed it — their risk.
The assets and instruments that will comprise your portfolio will also reflect that. To demonstrate the different types of portfolios, we will focus on the following assets:
- Large capitalization stocks. Large-cap stocks are stocks of large, established companies that have a market capitalization of $10+ billion and are less likely to be volatile in the long run. Examples include Apple (AAPL), Johnson & Johnson (JNJ) and Visa (V).
- Mid capitalization stocks. Mid-cap stocks are stocks of developing companies that are valued at $2-$10 billion. Such stocks typically offer a relative balance between volatility and growth opportunities. Examples include Papa John’s International (PZZA), Avis Budget Group (CAR) and Upwork (UPWK).
- Small capitalization stocks. Small-cap stocks are stocks of young, emerging companies and startups that have a market capitalization of $2 billion or less. These stocks tend to be the riskiest due to the overall uncertainty around the company’s future, but may also reward investors with exponential long-term growth. Examples include Progress Software (PRGS), Clean Energy Fuels (CLNE) and IMAX Corporation (IMAX).
- Fixed income securities. Fixed income securities are financial instruments that are designed to bring regular, stable income to their investors. The best examples of fixed income securities are long-term, reliable corporate bonds that you can invest in through a corporate bond exchange-traded fund, such as the Vanguard Long-Term Corporate Bond ETF (VCLT).
- Money market assets. Money market assets are primarily short-term debt instruments that essentially add cash or its equivalents into your portfolio. They are among the least volatile financial instruments and offer very low profit margins. Instead, their real purpose is to enhance the liquidity of your portfolio. The best-known money market instruments are U.S. Treasury Bills or T-Bills.
Note that we’re not including the more sophisticated instruments such as futures, swaps, options and other derivatives in this list.
While these instruments generally fall under the Equity category, which also includes stocks, they are more unpredictable and require considerable capital and financial knowledge in order to benefit.
As a result, they are more suitable for short-term investing or trading and not for long-term investing.
With that in mind, let’s explore the three most common types of investment portfolios, along with their purposes and potential compositions.
Type #1: Conservative Portfolio
The conservative stock portfolio offers minimum risk and, consequently, relatively low profit growth opportunities.
Its purpose is to provide you with steady returns over a period of at least five or ten years.
To achieve that, it should include stable, reliable assets and financial instruments that offer modest but steady growth.
The composition of your conservative portfolio could look like this:
- Fixed income securities — 75%.
- Large capitalization stocks — 15%
- Money market assets — 5%
Type #2: Diversified Portfolio
Just like any other type of portfolio, the diversified portfolio seeks to offer the best possible return with minimal risk.
However, instead of achieving that by focusing on low-risk assets like the conservative portfolio, the diversified portfolio spreads the risk over a greater variety of different assets.
This type of portfolio strikes a reasonable balance between profit and risk — it can offer more return than a conservative portfolio, while retaining some of its safety.
Your diversified portfolio could consist of the following assets:
- Large capitalization stocks — 40%
- Mid capitalization stocks — 30%
- Small capitalization stocks — 20%
- Fixed income securities — 5%
- Money market assets — 5%
As you can see, a diversified portfolio relies on different types of stocks.
However, the key to successful diversification is to ensure that the individual stocks under each category are also diverse and represent different industries and markets.
Type #3: Aggressive Portfolio
The aggressive portfolio prioritizes profits and growth over minimizing risk.
If you opt for an aggressive portfolio, you should be ready to take on some of the risk that comes with an aggressive investment strategy.
Since this approach prioritizes mid- to short-term profits and growth, it could focus on the following assets in the following proportions:
- Mid capitalization stocks — 40%
- Small capitalization stocks — 30%
- Large capitalization stocks — 30%
Note that we’re not including the fixed income securities and the cash instruments — that’s because they simply don’t offer enough return potential to satisfy the growth requirements of the aggressive portfolio.
How To Create A Stock Portfolio In 6 Steps
Now that we’ve covered the most common types of stock portfolios, let’s explore the process of creating the portfolio of your choice step by step.
#1: Understand Your Goals
Every investing journey should start with a clear set of goals.
If you’re looking to build an investment portfolio, that means understanding your capabilities, goals and, of course, your risk tolerance. All of these factors will directly influence the type and the contents of your portfolio.
For example, if you’re in your 20s with liquid cash on your hands and looking to retire early, you might consider a more growth- and profit-oriented approach that will allow you to maximize your profits and multiply your net worth.
Once you achieve that, you might want to reconsider your approach and focus on ensuring the sustainability of your assets via a more conservative approach.
In other words, the first and most important step to creating your investment portfolio is understanding what you personally seek to achieve with it.
#2: Do Your Research
While financial knowledge might not completely eliminate the risk that comes with investing in the stock market, it helps you make informed decisions that can help you manage that risk.
That’s why you should do thorough research and make sure you understand the financial markets before you proceed with your investment strategy.
#3: Draft Your Portfolio
Now that you have your goals and knowledge in place, you should draft the rough outline of your portfolio by selecting a roster of assets you wish to invest in.
You can do that by choosing individual stocks, bonds and instruments that fit within your strategy, or opting for ready-made solutions such as mutual funds or exchange-traded funds (ETFs).
#4: Run A Simulation Of Your Portfolio
Before you reach out to your broker and put real money into real assets, you should consider running a simulation of your portfolio to see how it could theoretically perform.
While a simulation may not necessarily predict what could happen to your real-life portfolio, it can teach you the basics of evaluating and managing your investments’ performance.
MNYMSTRS’ stock market simulation tool will allow you to do just that. As you proceed through the lessons, chapters and levels in the MNYMSTRS Academy, you will be rewarded with coins that you can use to build a simulated stock portfolio in the Arena and see how it performs in real time.
#5: Create Your Portfolio
Once you’ve done enough background research and experimentation, it’s time to pull the trigger on your portfolio and start investing.
Reach out to your investment broker or use an online investment platform to start building your portfolio. Keep in mind that you might not be able to invest in all of your desired assets in your desired proportions, right off the bat.
Remember to remain patient and focus on your investment goals.
#6: Monitor, Reassess & Rebalance
Congratulations, you’ve created a stock portfolio that fits your investment goals!
Be sure to proactively monitor your portfolio’s performance (or entrust that to your broker) to ensure that it’s growing and delivering returns just like it’s meant to.
If it doesn’t, you might have to go back to the drawing board to reassess and rebalance your assets.
For example, if you’re not seeing as much growth as you’d expected from your small-cap stocks, you might consider investing in a different set of stocks or in a different type of asset completely.
Alternatively, you might notice that your portfolio is more volatile that you’d hoped it would be. In this case, you might decrease the weight of your more volatile assets and increase your stake in the more stable assets.
Building and fine-tuning your stock portfolio could be a long process — but that’s the only way to ensure that your investments consistently deliver your desired profits.
Key Takeaways On How To Create A Stock Portfolio
A thoroughly planned investment portfolio can help you meet your financial goals earlier than you might expect.
Building an investment portfolio that will bring you consistent returns requires ample research and preparation, including:
- Understanding what kind of investor you are and what your goals are
- Researching and understanding how financial markets work
- Drafting a rough version of your investment strategy and your portfolio
- Testing your portfolio using a stock market simulation tool like the Arena at MNYMSTRS
Once you fully build your investment portfolio, you will need to proactively monitor its performance and make the necessary adjustments to ensure it’s meeting your risk and return goals.
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