How to build your personal finance portfolio?
Investing isn't a one-time thing where you buy an asset and wait for it to increase in value. It's so much more than that. As you get better at managing your money, you'll see that investing is a constant and consistent practice that allows you to make the most of your earnings.
To put it simply, investing is quite an art.
And a big part of mastering this art is about learning to build your personal finance portfolio. Or your investment portfolio, as some people call it.
You cannot simply throw together a mix of random assets and investment options. It takes a great deal of market research - and a good bit of understanding your own investor persona. Not sure about how you can get started? Don't you worry. We'll help you out.
Here are 5 simple yet essential steps to build your own personal finance portfolio.
Determine your risk profile
Whenever you make any investment, there is some degree of risk involved. For some investment options, this risk may be low, while for others, it may be higher. Before you build your portfolio, you need to be aware of how much risk you can bear. Essentially, you need to assess your risk profile. And this includes the following three aspects.
- Risk appetite
How much risk are you willing to take? That is your risk appetite. You need to use this aspect as a benchmark to choose the asset class and the product you wish to invest in.
- Risk capacity
How much risk are you capable of taking? That is your risk capacity. It depends on your age, your income level, your existing debts and other such factors.
- Risk tolerance
What are the boundaries of the risk you are willing to take on? How much of a loss can you bear? That is your risk tolerance.
Based on your assessment of the above aspects, you may be a conservative investor, a moderate investor or an aggressive investor.
- Risk appetite
Find the optimal asset allocation
Asset allocation is simply the manner in which your capital is allocated to the different assets in your portfolio. This will depend greatly on the kind of investor you are. More specifically, your asset allocation is influenced by the following factors:
- Your risk profile
- Your investment horizon
- The returns you expect
Let's take up a couple of examples to understand how asset allocation works.
You are a conservative investor with an investment horizon of 10 to 15 years, and you want to generate moderate returns over the long term. Your primary goal is capital preservation. In that case, here is a sample asset allocation that could work for you.
- 80% in long-term debt instruments
- 10% in cash and cash equivalents
- 10% in index funds
You are an aggressive investor with an investment horizon of 5 years, and you want to generate high returns over the medium term. In that case, here is a sample asset allocation that could work for you.
- 40% in direct equity
- 40% in equity funds
- 10% in cash and cash equivalents
- 10% in gold or real estate
Diversify. Diversify. Diversify.
Diversification goes hand-in-hand with asset allocation. When you are deciding which asset class and which product to invest in, it is often easy to get carried away and rely too heavily on one option or two.
For example, if your parents have had great success with real estate investments, you may be inherently biased in favor of such assets. Or if you know of a few friends or colleagues who may have made good profits by investing in equity, you may tend to lean towards that option.
However, there is one key issue with putting most or all of your money in one asset class or investment option. Your overall portfolio risk increases. If that one asset does not perform well, you could lose a lot of your capital.
Diversification can ensure this does not happen. It is essentially the practice of diversifying your investment portfolio by including different kinds of investments. You can diversify your personal finance portfolio in the following ways:
- Diversify across asset classes (like equity, debt, and cash and cash equivalents)
- Diversify within an asset class (like large cap stocks, mid cap stocks and small cap stocks)
- Diversify across sectors (like IT, retail, healthcare, automobiles and so on)
- Diversify across investment horizons (like long-term, medium-term and short-term assets)
- Diversify across risk categories (like high-risk, medium-risk and low-risk investments)
- Diversify across investment goals (like capital appreciation, capital preservation, additional income and so on)
Revisit your investments periodically
Once you've built up an ideal portfolio - one that is diversified and follows optimal asset allocation - you can rest easy. But only for a while. Because you need to revisit your investments periodically. Here's why this is important.
- It helps you keep an eye on how your investments are performing
- It allows you to identify underperforming assets
- It helps you recognize any losses early on, so you can plan your next move accordingly
- It ensures that your portfolio is aligned with your goals
Rebalance your portfolio as needed
When you revisit your portfolio, you also need to check if your initial asset allocation has been maintained. Often, this will not be the case because the value of the assets in your portfolio change with time. Here's an example to make this clearer.
Portfolio rebalancing: An example
Say your ideal asset allocation is 50:50 - that is, 50% in equity and 50% in debt. You have Rs. 1,00,000. So, you invest it as follows initially.
- Rs. 50,000 in equity
- Rs. 50,000 in debt
Six months later, say you revisit your portfolio and find that equity has performed well. Your new portfolio now looks something like this.
- Rs. 80,000 in equity
- Rs. 60,000 in debt
The asset allocation has now become 80:60. You need to bring it back to 50:50. So, you should sell Rs. 10,000 worth of equity and reinvest that in debt instruments. That brings the new asset allocation to 50:50 as follows:
- Rs. 70,000 in equity
- Rs. 70,000 in debt
So, that sums up the process for building and maintaining a good personal investment portfolio. Now, are there any essential must-haves for every portfolio? Let's find out.
What should an ideal personal finance portfolio include?
Aside from the general process involved in building your personal finance portfolio, you also need to be aware of the key things you should include in there. Here's a quick guide that covers the most important financial products your portfolio must have.
Investments are essential parts of every personal finance portfolio. Ideally, your investments must be aligned with your goals. So, you need to have a mix of investments for your short-term goals, your medium-term goals and your long-term goals.
Life insurance is also a very important part of your portfolio. It helps secure your future and your family's. In case something untoward happens to you, your insurance plan acts as a safety net for your family and ensures that they can continue to meet their life goals as planned.
You can choose from different kinds of life insurance plans like term plans, savings plans, ULIPs, retirement plans and more, based on your specific needs.
An emergency fund
An emergency fund needs to be accessible, liquid, and enough to meet at least six months' worth of expenses for you and your family. Some experts also advise building an emergency fund that's equal to 10 months' or 1 year's worth of your income.
Here are some products that you can make use of to create your emergency fund.
- A high-interest savings account
- Certificates of Deposit
- Money market accounts
- Short-term high-yield bonds
- Blue chip stocks
If you're a salaried person, you may find that with time, your salary hikes may push you into a higher income slab. And with that comes a higher rate of tax. Fortunately, there are many tax-saving investment options that can help you counter this burden of taxation. You also need to include such tax-saving products in your portfolio for optimal financial results.
Here are some popular tax-saving investment options in India.
- Public Provident Fund (PPF)
- Tax saving fixed deposit
- National Savings Certificate
- National Pension System (NPS)
- Equity Linked Savings Scheme (ELSS)
- Unit Linked Insurance Plans (ULIPs)
- Sukanya Samriddhi Yojana (SSY)
- Senior Citizen Saving Scheme (SCSS)
This guide should help you build the right personal finance portfolio for your needs. If you are just getting started, it may seem a bit overwhelming. But take it one step at a time, and you'll see how easy it is to build the right portfolio for your investments.
Read next: HAVE YOU PLANNED FOR EMERGENCIES? IF NOT, TAKE THESE STEPS RIGHT NOW.
An emergency fund, as you've seen, is an essential part of your portfolio. If you haven't started building your emergency fund yet, our blog can help you get started.
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