How to build an investment portfolio

What is an investment portfolio? 

An investment portfolio is your collection of financial assets – shares, bonds, exchange-traded funds (ETFs), commodities and more. Rather than individual pieces working in isolation, these assets are designed to work together to build wealth over time.

A well-structured portfolio balances growth potential with risk management, tailored to your specific goals. Whether you're saving for retirement, a home deposit or long-term financial security, the way you structure your portfolio can make a significant difference to your outcomes.

Why should I build a diversified investment portfolio? 

Putting all your money into a single investment is like putting all your eggs in one basket. If that investment underperforms, your entire financial position could suffer. A well-constructed portfolio spreads your capital across different asset types, markets and sectors, reducing the impact of any single investment's poor performance.

This approach is called diversification, and it's one of the most powerful tools available to investors. Historically, diversified portfolios have tended to deliver more stable returns over time, smoothing out the inevitable ups and downs of individual markets.

Understanding your investment goals and risk tolerance

Before you start building, you need a clear picture of what you're building towards. A well-balanced portfolio typically involves careful consideration of your personal circumstances, goals and risk tolerance.

Investment goals

Your investment goals should be specific. Specific investment goals can help guide your portfolio decisions. 'Building wealth' is quite broad – clearer goals might include 'saving $200,000 for a property deposit in seven years' or 'building a retirement fund of $1 million over 25 years'. Clear goals can help determine which investments make sense for your timeframe.

Risk tolerance

Risk tolerance is equally important. It's the balance between two factors: your capacity for risk (how much you can afford to lose without derailing your financial plans) and your appetite for risk (how comfortable you are watching the value fluctuate). If watching your portfolio value fluctuate causes significant stress, a lower-risk approach might suit you better.

Types of investments to consider

Once you've determined your asset allocation, you need to select specific investments. You might consider:

1. Index funds and ETFs: which track market indices like the S&P 500 (a US large-cap index) or MSCI World Index (covering global developed markets). They offer broad market exposure, low costs and minimal management requirements. For many investors, particularly those starting out, index funds can provide an effective foundation.
2. Individual shares: allow you to invest directly in companies you believe in. This requires more research and monitoring, but gives you greater control over exactly what you own. You might focus on established companies with strong track records or include some growth-oriented stocks with higher potential returns.
3. Bonds and bond funds: can provide stable income and help balance equity risk. Government bonds are typically lower risk, while corporate bonds offer higher yields in exchange for slightly more risk.
4. Sector-specific or thematic investments: let you target particular areas of the economy. You might invest in clean energy, healthcare innovation or emerging technologies if you believe these sectors will outperform.

Research can help inform your investment decisions. Look at historical performance, but remember past returns don't guarantee future results. Consider factors like management quality, competitive position, financial health and valuation. For funds, examine fees carefully – even small differences in annual costs compound significantly over time.

Asset allocation: building your mix

Asset allocation is how you divide your portfolio across different asset classes. The main asset classes include:

• Shares (equities): offer growth potential but come with higher volatility. Companies can increase in value over time, and many pay dividends, providing both capital growth and income. However, share prices can fall significantly during market downturns.
• Bonds (fixed income): generally, more stable than shares. When you buy a bond, you're lending money to a government or company in exchange for regular interest payments. Bonds tend to be less volatile, making them useful for balancing riskier assets.
• Cash and cash equivalents: provide stability and liquidity. This includes savings accounts, money market funds and short-term deposits. While returns are typically modest, these assets aim to preserve capital, though returns may not keep pace with inflation.
• Alternative investments: like commodities and cryptocurrencies can add further diversification. These often move independently of traditional shares and bonds, potentially improving your portfolio's overall risk-return profile.

The right mix depends on your goals and risk tolerance

Asset allocation chart

Diversification strategies

Diversification doesn't stop at choosing different asset types. Within each asset class, spread your investments across:

• Geographic regions: global markets don't always move in sync. A portfolio with exposure to Asia, Europe, North America and emerging markets can be less vulnerable to regional economic problems.
• Sectors and industries: technology, healthcare, financials, consumer goods and energy all perform differently depending on economic conditions. Diversifying across sectors can help protect against industry-specific downturns.
• Individual securities: even within sectors, individual companies can face unique challenges. Holding multiple securities can reduce the impact if one company underperforms.

Steps to start building your portfolio

1. Determine your budget: decide how much you can comfortably invest without compromising your emergency fund or short-term financial needs. Many investors start with monthly contributions, making portfolio building a regular habit rather than a one-time event. 
2. Open an investment account: you'll need a brokerage or investment platform that provides access to the markets and assets you want. Compare fees, available markets and platform features before choosing. 
3. Make your initial investments: start with your core holdings, like ETFs. You can add more specific investments over time as you gain experience and confidence. 
4. Set up regular contributions: automating monthly investments helps build your portfolio steadily while taking advantage of dollar-cost averaging. This means you buy more units when prices are low and fewer when prices are high, potentially reducing your average cost over time. 
5. Monitor your portfolio regularly: checking too frequently may lead to reactive decisions based on short-term movements. Daily price movements are normal parts of investing, though longer-term trends tend to be more significant for portfolio decisions. Quarterly or six-monthly reviews are usually sufficient unless your circumstances change significantly.
6. Rebalance when needed: markets move constantly, which means your carefully planned asset allocation will drift over time. If shares perform well, they might grow from 60% to 70% of your portfolio, increasing your risk beyond your original intention. Rebalancing brings the portfolio back to your target allocation. You might do this annually, or when any asset class moves more than 5% away from its target. Rebalancing forces you to 'sell high and buy low' – selling assets that have grown beyond their target and buying those that have fallen behind.

How to build an Australian share portfolio

Building an Australian share portfolio is an excellent starting point for investors embarking on their investment journey. Despite Australia making up just over 2% of the global share market, many Australian investors choose to focus on their home market due to familiarity with local brands, favourable tax treatment of dividends, and a preference to avoid currency risk associated with international investments. 

Understanding the local investment landscape and its unique benefits can significantly enhance your portfolio-building strategy. 

Key considerations

• Local taxation environment: a major benefit of Australian shares is franking credits, which prevent 'double taxation' on dividends. After companies pay corporate tax, dividends are 'franked', giving shareholders a tax credit. If franked dividends exceed your tax rate, you might receive a refund. Reinvesting dividends through a dividend reinvestment plan (DRP) can also boost your investment over time.
• Lack of sector diversification: the Australian share market is heavily concentrated in a few sectors, with financials and resources making up nearly half of the ASX 200 index. This exposes investors to sector-specific risks. To achieve a diversified portfolio, consider international opportunities that provide both sector and geographic diversification.

Two ways to build an Australian equity portfolio

1. Buy ETFs: ETFs like IOZ and VAS provide broad exposure by investing in the largest stocks on the ASX, with IOZ covering 200 and VAS covering 300 stocks. These ETFs, managed by US firms iShares and Vanguard, incur annual management fees but offer diversified market exposure.
2. Buy 10 largest ASX stocks: for direct investment, consider purchasing shares of the 10 largest ASX companies. This approach gives you a portfolio representing about 45% of the ASX's total value and avoids management fees, as you own the stocks directly rather than through US-based firms.

How to build an international share portfolio

Building an international share portfolio opens the door to investing in some of the world’s most significant and profitable companies. Larger markets like the US, Japan, and China provide vast opportunities. Expanding your portfolio internationally can enhance diversification and access to a broader range of sectors.

Key considerations

• Currency risk: when investing internationally, one significant risk is currency fluctuations. If you own US equities and the US dollar weakens against the Australian dollar by 5%, your investments lose value in Australian dollar terms. Conversely, if the US dollar strengthens by 5%, your portfolio gains value.
• Hedging to minimise this risk: hedged ETFs use forward contracts to lock in exchange rates, reducing the impact of currency fluctuations. However, hedging can limit diversification benefits and increase reliance on the Australian economy. It can also complicate investments in ETFs tracking multiple markets.

Two ways to build an international equity portfolio

1. Regional focus: dividing your investments by region – North America, Asia, and Europe – allows you to tailor your portfolio to specific economic growth predictions. For instance, if you expect the US to outperform Europe, you could shift investments from European to US-focused ETFs.
2. Developed and emerging markets focus: another strategy is to allocate investments between developed markets (like the US and Australia), which comprise about 87% of global stock markets, and emerging markets (like China and Brazil), making up about 13%. Adjust your weighting based on your risk tolerance and investment goals.

How to build a fixed income portfolio

Building a fixed income portfolio is fundamental for investors seeking to balance portfolio volatility and achieve stability when growth assets like equities and property markets are underperforming. Despite being sometimes misunderstood, fixed income plays a crucial role in diversifying and fortifying your investment strategy. 

What is fixed income? 

Fixed income is a broad asset class that includes cash, term deposits, and bonds. 

Two ways to invest in fixed income

Investing directly in individual bonds can be challenging due to market transparency issues and high transaction costs. Instead, consider these strategies:

1. Bond ETFs: a bond ETF provides a basket of bonds tracking an underlying index, which may include government, semi-government, or corporate bonds. Bond ETFs are traded on exchanges and allow access to a wide array of bonds with the flexibility to buy or sell during market hours. This accessibility provides a convenient way to diversify your portfolio and manage risk exposure.
2. Hybrid securities: which, while not strictly part of fixed income, are popular for generating income streams. Hybrid securities blend elements of debt and equity, often providing higher interest rates than traditional bonds. However, the complexity of individual hybrids requires careful analysis. 

Common portfolio building mistakes to avoid

Chasing performance 

Investing in last year's top performers can lead to disappointment. Markets are cyclical, and assets that have recently outperformed frequently underperform in subsequent periods.

Ignoring fees 

A fund charging 2% annually instead of 0.2% costs you nearly 40% of your potential returns over 30 years. Always account for fees in your investment decisions.

Emotional decision-making 

Selling during market downturns or buying during euphoric rallies typically damages long-term returns. Stick to your strategy even when markets test your resolve.

Insufficient diversification 

Holding just a handful of shares or concentrating too heavily in one sector or region can increase your risk unnecessarily.

Neglecting to rebalance

Letting your portfolio drift away from your target allocation can result in taking more risk than intended or missing out on growth opportunities.

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¹ When investing with us, you’ll do so via our share trading platform using our custodial model. This means that we manage, hold and safeguard securities you choose to buy and sell on your behalf. Via our custodial model, you’ll be able to buy and have a stake in actual assets – for example, shares in an ASX 200-tracking ETF or ASX 200-constituent company. You’ll also be entitled to dividends if any are paid, and granted voting rights if applicable.