To build a balanced investment portfolio, diversify your investments across different asset classes, such as stocks, bonds and real estate. Consider your financial goals, time horizon and risk tolerance to determine your right asset allocation.
Maybe you’ve heard the phrase, “Don’t put all your eggs in one basket.” This is the key to building a well-rounded portfolio that both reduces your risk and helps you reach your financial goals.
There’s no single right approach to investing. What works for you, your lifestyle and your financial goals may completely differ from what suits another investor. There are numerous ways to create an investment portfolio, and this diversity is what makes investing fascinating.
But how do you actually build one? By the end of this guide, you’ll know the various portfolio types, the benefits of diversification, and how to build your own portfolio.
How to manage an investment portfolio
You can create and manage a well-rounded investment portfolio by assessing your risk tolerance, diversifying your assets, and regularly rebalancing your asset allocation. The most common investments are stocks and bonds, but your portfolio can include various types of investment assets.
Some investors opt for portfolios that include gold, real estate, cryptocurrencies and other asset classes. Regardless of what your focus is, an investment portfolio is a fundamental part of wealth building. Whether you’re saving for a specific goal such as college, a home or retirement, investment portfolios are a good choice for anyone looking to grow their income or nest egg.
Determining your risk tolerance
Understanding your risk tolerance can help you determine the level of risk you are comfortable with, guiding you to pick investments that align with your personal preferences.
By assessing your risk tolerance, you can strike the right balance between risk and reward. You can determine your risk tolerance by considering your financial goals, current life stage, investment time horizon, portfolio size and investor comfort level.
Some investors may be more conservative, preferring stable investments with lower potential returns, while others may be more willing to take on higher risks in pursuit of greater rewards.
The timeline of your investing goals also matters. A helpful rule of thumb is to opt for riskier investments, such as stocks or funds, when your goals are further away. For closer goals — for instance, buying a car next year — look for more conservative strategies involving bonds or even cash.
Remember, your personal risk tolerance should guide your portfolio construction. This ensures that you don’t lose sleep over market fluctuations while still maintaining the potential for growth.
Building a diversified portfolio is closely tied to risk tolerance because it allows you to spread your investments across different asset classes with varying levels of risk. This diversification can help lower the impact of a single investment’s performance on your overall portfolio.
Understanding diversification
Diversification involves spreading investments across various asset classes to mitigate risk. This is because different asset classes tend to perform differently under varying market conditions.
When one asset is down, another may be up, providing a cushion against volatility. By selecting a mix of assets that suit your risk tolerance and financial goals, you can achieve a balanced portfolio.
Tip: Mix up your investments – this way, if one investment drops in value, others may compensate and help prevent significant losses.
One easy way to achieve diversification is by investing in index funds and exchange-traded funds (ETFs) [Glossary: a type of investment that combines the diversification of a mutual fund with the flexibility of a stock, allowing investors to gain exposure to a basket of assets in a single trade]. These low-cost funds offer exposure to a wide range of stocks and bonds in a single security.
Achieving diversification with capital allocation
A diversified portfolio is built on the principle of capital allocation. It allows you to spread your investments across different asset classes, based on factors such as risk tolerance, market conditions and investment objectives.
Your investment portfolio can include assets such as:
- Stocks
- Bonds
- Real estate investments, such as real estate investment trusts (REITs)
- Commodities
- Exchange-traded funds (ETFs)
- Cryptoassets
- Collectibles.
By allocating your money smartly, you can potentially capture the upside of different asset classes when they perform well while mitigating the downside risk when others fall in value.
This approach helps to reduce the overall volatility of your portfolio and increases the likelihood of achieving stable long-term returns.
Tip: Investors must possess strong capital allocation skills to manage their desired risk level, returns and financial goals.
Keep in mind that as market conditions change, your allocation can get skewed. For example, if one investment skyrockets, your portfolio’s stock percentage might also shoot up.
Rebalancing is the process of readjusting your portfolio through buying and selling assets. This ensures that your allocation stays on track and aligns with your strategy.
Different types of portfolio allocations
When it comes to portfolio allocation, there’s no one-size-fits-all approach. The key is to find the right balance that suits your individual goals and risk tolerance. If you don’t know where to start, here are the three most popular portfolio types: aggressive, moderate and conservative.
Aggressive portfolio allocation
An aggressive portfolio allocation focuses on maximizing potential returns by taking on a higher level of risk. This approach is suited for individuals who have a longer time horizon and who are comfortable with the volatility that comes with higher-risk investments.
The goal is to achieve substantial growth by allocating a significant portion of investments to high-growth assets such as stocks.
Typical focus: Stocks
Time horizon: 10 years or more
Example asset allocation:
- 80–90% in stocks
- 5–10% in commodities and/or crypto
- 0–10% in bonds
Moderate portfolio allocation
This allocation typically consists of a more balanced mix of investments, aiming to provide moderate growth while preserving capital. In a moderate portfolio, you can expect to find a blend of stocks, bonds and cash.
A moderate allocation allows for potential growth through stocks while providing stability and income generation through bonds. Its focus is on achieving steady returns over the long term, offering a middle ground for those seeking a more balanced investment strategy.
Typical focus: Stocks and bonds
Time horizon: 0 to 10 years to retirement
Example of asset allocation:
- 60–75% in stocks
- 5–15% in bonds
- 0–5% in commodities and/or crypto
Conservative portfolio allocations
This strategy focuses on preserving capital and minimizing risk. It typically consists of a higher percentage of fixed-income securities, such as bonds and cash equivalents, compared to more volatile asset classes such as stocks.
While the potential for high returns may be limited, this approach aims to provide stability and protect your investment against market downturns.
Typical focus: Bonds
Time horizon: Less than three years
Example of asset allocation:
- 30–60% — stocks
- 70–40% — bonds
Tip: Regardless of how low-risk a portfolio may seem, you should always be prepared for potential losses.
How to build your own diversified portfolio: four questions to ask
Here are four questions you should ask yourself as you get ready to start building your own investment portfolio. You can either tackle these considerations on your own or talk with a financial advisor who can help walk you through each step.
1. What are my financial goals and current life stage?
Understand what you want to achieve financially and consider your current life stage. Are you saving for retirement, buying a house or starting a family? Your goals and life stage will shape your portfolio strategy.
Investors with few long-term commitments may choose a more aggressive portfolio, while those with financial obligations such as a mortgage may benefit from a more moderate approach.
Tip: If you’re nearing or in retirement, a conservative portfolio may better suit your financial objectives and risk tolerance.
2. How will my asset allocation look?
Decide how you want to distribute your investments across different asset classes, such as stocks, bonds, real estate or commodities. This allocation should align with your goals, time horizon and risk tolerance.
By diversifying your investments across various asset classes, you can potentially reduce the impact of market fluctuations on your overall portfolio performance.
If you have a long investment horizon and a higher risk tolerance, you might allocate a larger portion of your portfolio to stocks. If you have a shorter time horizon or a lower risk tolerance, you might lean towards more conservative investments such as bonds.
Diversifying your portfolio can also involve distributing your funds across various sectors, asset classes and geographical regions.
For instance, if your portfolio only consisted of stocks, you could consider diversifying it as follows: 25% in international stocks, 25% in high-growth stocks, 25% in small-cap stocks, and 25% in value stocks.
This same approach can be applied to other asset types, including commodities and crypto. By tailoring your portfolio allocation to your needs, you can strike a balance that offers both stability and growth potential.
3. What is my risk tolerance?
Evaluate how comfortable you are with taking on risk. Are you willing to accept potential losses in order to pursue higher returns? Knowing your risk tolerance helps you determine the appropriate level of risk in your portfolio.
This question goes hand in hand with setting your financial goals. If you have a bigger tolerance for risk, you might be more willing to consider more volatile investments, such as stocks or cryptocurrencies. If you’re less open to risk, consider safer investments such as ETFs or blue-chip stocks.
4. What research do I need to do?
Once you’ve decided what types of assets you want in your portfolio, it is time to start determining which ones you actually want to add. Start reading up on the latest news and analysis, or pick out some potential targets and look into their performance history.
The more you know, the better equipped you’ll be to make informed decisions for your portfolio.
Three tips for creating a well-rounded portfolio
Gauging the scale of your investments is an essential part of building a well-rounded portfolio as it helps to spread your assets across different markets. Diversifying your assets promotes adaptability and balance when inevitable economic shifts occur. Here’s more detail on these tips.
| Tip | Explanation |
|---|---|
| Think global and local | Diversifying your investments across different regions can reduce the impact of localized risks and take advantage of potential growth in various markets. Striking a balance between global and local investments means that you can position yourself to benefit from both domestic stability and international growth. |
| Be ready to adapt | Markets are influenced by many factors, including economic conditions, technological advancements and social trends. Investors must stay informed and flexible. Read market news, monitor your investments regularly, and adjust your portfolio as needed. |
| Don’t be afraid to rebalance | Periodically reassess your portfolio to ensure that it aligns with your risk tolerance and investment goals. Adjusting the allocation of your investments can help you manage risk and potentially boost your returns. |
Final thoughts
When building your portfolio, remember the importance of diversification. Allocating your investments across different asset classes is a key component of this.
By spreading your investments across various assets, you can lower the risk associated with any single investment and potentially boost your chances of achieving consistent returns over time.
Maintaining a disciplined approach and avoiding making impulsive decisions can help you stay on track and potentially grow your wealth.
Visit the eToro Academy and learn how to build your own diversified portfolio.
FAQs
- What is the importance of building a diversified investment portfolio?
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Building a diversified investment portfolio is crucial because it helps to minimize risk and maximize returns. By spreading investments across different assets or asset classes, you reduce the impact of any single investment’s performance on your overall portfolio.
- How do I determine my risk tolerance?
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Consider factors such as your financial goals, time horizon, income stability and personal comfort with market fluctuations. It is important to strike a balance between risk and reward that aligns with your individual situation and investing goals.
- What are the different types of portfolio allocation?
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There are three main types of portfolio allocation: conservative, moderate and aggressive. A conservative allocation focuses on low-risk investments, a moderate allocation aims for a balance between risk and return, and an aggressive allocation emphasizes high-risk investments with the potential for growth.
- Can I have a mix of different allocation types in my diversified portfolio?
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Yes, it is common to have a mix of different allocation types in a diversified portfolio. For example, you might allocate a portion of your portfolio conservatively for stability and income generation while allocating another portion more aggressively for long-term growth. The specific mix will depend on your risk tolerance and investment objectives.
- How can I achieve diversification in my portfolio?
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Diversification can be achieved by investing in a variety of assets or asset classes, including stocks, bonds, real estate, commodities and other investment vehicles.
It is important to spread your investments across different sectors, industries and geographic regions to reduce the reliance on any single investment.
This information is for educational purposes only and should not be taken as investment advice, personal recommendation, or an offer of, or solicitation to, buy or sell any financial instruments.
This material has been prepared without regard to any particular investment objectives or financial situation and has not been prepared in accordance with the legal and regulatory requirements to promote independent research. Not all of the financial instruments and services referred to are offered by eToro and any references to past performance of a financial instrument, index, or a packaged investment product are not, and should not be taken as, a reliable indicator of future results.
eToro makes no representation and assumes no liability as to the accuracy or completeness of the content of this guide. Make sure you understand the risks involved in trading before committing any capital. Never risk more than you are prepared to lose.