Building an investment portfolio: ten things you need to know
Putting together an investment portfolio can seem daunting, but with a bit of research anybody can build a low—cost portfolio that targets strong returns while trying to manage the risks. In the first of a series of articles, we look at ten things any investor needs to know.
UK interest rates have gone up for only the second time in a decade. Good news for savers but, with only a 25 basis point rise, your cash on deposit with the bank still may not keep pace with inflation. If you want your money to work harder, consider building your own investment portfolio. It might seem a daunting task, but doesn’t have to be complicated.
Here are ten things you need to know before you get started.
1. Define your objectives
Think about what you want your investment portfolio to achieve and over how long: are you saving for retirement in 30 years? Are you trying to build up a deposit to buy a house in the next two years? The right portfolio for you will look different depending on the financial goals you have in mind, so get this clear from the start.
2. Income or growth?
Are you investing to grow your capital, or to generate a regular income from your investments? The second option is popular with retirees. For income, you could choose equity income funds, bonds, or shares in companies that pay out regular dividends to shareholders, for example. You can spend the income or reinvest dividends to ramp up your returns. If you want capital growth, you can choose shares in companies which plough their cash back into their business to grow instead of returning money to shareholders.
3. The types of investment
If you’re new to investing, you’ll need to get a handle on the different types of asset classes and investment vehicles available to buy. These include individual stocks and bonds, but many novice investors will start off by pooling their money with others in a fund managed by an investment professional. Funds will usually be cheaper to buy and sell on an investment platform, and a better way to spread your risk than buying one or two shares. Fund managers charge fees, but you can cut management costs by choosing passively managed funds such as exchange traded funds (ETFs) or index trackers.
You can search the range of ETFs offered by IG here.
4. Why diversify?
A crucial principle in investing, diversification essentially means not putting all your eggs in one basket. By having a diverse mix of investments from across the major asset classes (stocks, bonds, property, alternatives, cash), your holdings should each behave differently, meaning it’s less likely that everything in your portfolio will fall at once.
Read more about investing and the power of diversification
5. Size matters
While diversification is important, it’s also a mistake to stuff your portfolio full of too many positions. You could end up doubling up your exposure, and paying too much in charges and dealing costs. It’s about striking the right balance: a handful of carefully chosen positions is probably fine if you’re finding your feet as an investor, but even just one well diversified multi—asset fund would be a good start.
6. Investments can go down as well as up
When you are building your portfolio, be realistic about returns. Markets rise and fall, and that means the value of your portfolio can go down as well as up. Investing is not a get—rich—quick scheme, you need to play the long game to have the best chance of success, and think carefully about what you can afford to lose.
7. You can’t time the market
Patience is a virtue when it comes to investing. A common mistake people make is to panic when things are falling and sell out to try to limit their losses, but even the world’s best investors admit they can’t correctly time the market. A better tactic is to ‘ride the dips’ — in fact, professional investors buy more of the stocks they like when prices fall.
Learn more about whether it’s time in the market or timing the market
8. Avoid churning
Ideally, when building your portfolio you will do your research and find things you think can perform well over the long term. Excessive buying and selling (known as ‘churning’) will end up costing a lot in dealing charges, and this could easily cancel out any gains you make from the investments themselves. Many professional fund managers buy and hold their stocks for at least three to five years, so you might want to take a similar approach.
9. Understand risk
Generally, the more risk you are willing to take, the greater the potential reward. But what is an acceptable level of risk to you? It will depend on many things, such as your life stage, when you will need to access your money, and how relaxed you feel about losses. It may change over time as you focus more on preserving rather than growing your capital as you age. Online robo—advisers usually have questionnaires which can help you work out your risk tolerance, why not try out one of these to see what portfolio mix they recommend for you?
10. Buy what you know
There are plenty of weird and wonderful investment opportunities out there which promise huge returns, but might not be what they seem. Buying investments you understand, such as shares in brands you recognise or funds investing in your home market, is probably a safer strategy than buying what looks like the hottest new thing and might prove too good to be true.