What is an investment portfolio?

What is an investment portfolio?

05.09.2024

An investment portfolio is a collection of assets, such as stocks, bonds, mutual funds, exchange-traded funds (ETFs), real estate, cash alternatives, and more. 

Each portfolio looks a bit different, and you can choose to combine any number of assets. Some investors choose narrower portfolios with only stocks and bonds, while others build more diversified portfolios with many different types of asset classes. 

If you’re considering building an investment portfolio, keep reading to learn the different types of portfolios, how to build one, the tax considerations, and more.

Types of investment portfolios

There are many different styles of investment portfolios, but most can fit into four different categories: growth, income, value, defensive, and blended.1

Growth portfolio

A growth portfolio is a more aggressive type of investment portfolio that seeks a balance of higher risk and higher reward. It includes more growth stocks, meaning stocks from companies expected to grow quickly. These companies don’t usually pay dividends and instead often reinvest their profits back into the business.

A growth portfolio may include speculative investments, such as domestic, international, and emerging-market stocks, as well as cryptocurrencies.

The high-risk, high-reward nature of a growth portfolio may be suitable for young investors. Those investors have a long time horizon, meaning they’ll be able to bounce back from any potential market downturns.

Income portfolio

An income portfolio seeks to build a consistent source of income. Investors in an income portfolio are likely to invest in dividend-paying stocks that pass along a portion of their profits to their shareholders. They may also invest in real estate investment trusts (REITs), which also can provide income for their investors.

Though income investors may also invest in some growth stocks, they prioritize a steady stream of investment income over capital appreciation. Though anyone can build an income portfolio, one may be  more suitable for an older investor or one entering retirement who wants to replace the income stream from their job.

Value portfolio

A value portfolio consists of value stocks, which appear to be trading at a lower price relative to their actual worth. Value stocks are often stocks of larger, more established companies that pay dividends, have high earnings, or demonstrate other good fundamentals.

Unlike growth stocks, value stocks don’t necessarily have massive growth potential, but that’s because they’re already successful and well-established. Value stocks are also more likely than growth stocks to pay dividends, which may be important for investors who want to combine capital appreciation with a recurring source of income.

Value stocks may be a good option for long-term growth and someone with a moderate risk tolerance. They aren’t necessarily as lower-risk as a bond portfolio, but they are can be less risky than a growth portfolio.

Defensive portfolio

A defensive portfolio invests primarily in defensive stocks. Generally viewed as the opposite of a growth portfolio, a defensive portfolio accepts the tradeoff of a lower reward for the benefit of a lower risk. 

These stocks often share a few characteristics, including a good history of dividends and consistent demand, even during market downturns. Defensive stocks tend to remain stable during all phases of the business cycle, meaning their losses may be lower than those of other stocks.

Defensive stocks may be ideal for risk-averse investors who prioritize safer investments  over large earnings. These investors could be nearing retirement and want to avoid potential losses of their nest eggs.

Balanced portfolio

A balanced portfolio contains a mix of stocks and bonds to reduce potential volatility while still allowing for plenty of market growth. 

Balanced portfolios can lean more heavily toward either stocks or bonds, depending on the needs of the investor. Someone might start with a balanced portfolio that leans more heavily toward stocks but then increases the bond percentage over time.

Such a portfolio can be ideal for many investors, especially those with mid- to long-range time horizons and who are comfortable with short-term price fluctuations.

Understanding the composition of an investment portfolio

An investment portfolio is someone’s entire collection of financial assets. A portfolio may include traditional assets like stocks, bonds, and cash alternatives. It can also include alternative assets like real estate, cryptocurrency, commodities, and more.

Read more: What are stock options & how do they work?

Each investment portfolio is unique and should be customized based on the investor’s preferences, risk appetite, and investment time horizon.

Your investment portfolio isn’t just made up of the assets in a single investment account. Instead, it consists of all your assets across all accounts, including your 401(k) plan or individual retirement account (IRA), taxable investment account, deposit accounts, and more.

How to build an investment portfolio

Building an investment portfolio may sound daunting, but it doesn’t have to be. In fact, starting a portfolio can be quite simple.

1. Decide if you want help

The first thing you’ll have to decide before you start building your portfolio is whether you want help. While it’s entirely possible to build and manage your own investment portfolio, there are also professional options that can help.

First, you can choose to work with a trusted financial professional to help build and manage your portfolio. This option offers the benefit of professional expertise, as well as reduced stress and time on your part.

Another option is to open an account with a robo-advisor. A robo-advisor is typically a digital platform that uses an algorithm to build your portfolio based on your answers to various questions. It chooses your investments and then rebalances and adjusts your portfolio as needed.

Finally, you can choose to manage your own portfolio. This may be a good option for someone who is comfortable researching and choosing their own stocks or who wants to build a simple index-fund-based portfolio.

2. Consider your investment profile

Before you start choosing investments for your portfolio, it’s important to consider your investment profile. By that, we mean it’s important to gain a greater understanding of your own investment goals, risk tolerance, and time horizon. 

These are among the first questions a professional investment manager would ask you, and it’s important to ask yourself those same questions. Knowing your goals, risk tolerance, and time horizon can help you choose the appropriate balance of assets to help meet your goals while taking on the appropriate risk level.

3. Open an investment account

Once you feel ready to start investing, you’ll first have to open an investment account. There are several different types of investment accounts, the most popular being taxable and tax-advantaged.

A taxable account is one where your investment gains, dividends, and interest are subject to taxes. You can open this type of account with any investment firm. It can be used to save for any goal, and you can typically trade as much as you want at any time.

Another type of investment account is a tax-advantaged account, which can include a 401(k) plan and IRAs. As long as the money remains in these accounts, your earnings aren’t subject to current income or capital gains taxes. However, these accounts have some restrictions, including contribution limits, withdrawal limitations, and use limitations.

If you have a tax-advantaged account available to you, it may be the best place to start since  you can save a significant amount on your taxes. However, if you don’t have access to a tax-advantaged account, you’ve already maxed out your tax-advantaged account, or you’re saving for a medium-term goal, then a taxable account might be the right choice.

4. Determine the best asset allocation

Asset allocation refers to the mix of investments in your portfolio. The ideal asset allocation for any person depends on their investment goals, risk tolerance, and time horizon. Once you’ve identified your investment profile, you can choose investments and fit.

For example, someone with a low risk tolerance or a short time horizon is likely to choose an asset allocation that leans toward lower risk and lower reward. Meanwhile, a young investor saving for retirement is likely to choose a higher-risk, higher-reward asset allocation. Meanwhile, most investors fall somewhere in between those and will choose an asset allocation that offers some risk but also some assets that mitigate risk.

There is not necessarily one right asset allocation for everyone. Two people of the same age with similar goals may choose very different asset allocations.

Finally, remember that the asset allocation you choose when you first open your investment account won’t be your asset allocation forever. Your asset allocation should change over time as your time horizon and goals change.

5. Choose your investments

Finally, once you’ve identified your ideal asset allocation, it’s time to choose investments that align with it. For  many investors, a good way to choose investments is to invest in a pooled investment such as a mutual fund or ETF. These investment vehicles allow you to access many underlying assets in a single investment.

Some people may choose to invest in several different mutual funds or ETFs. Meanwhile, others will choose something like a target-date fund, which automatically shifts its asset allocation and becomes more conservative over time as the target-date approaches. A target-date fund can serve as an entire portfolio in just one investment. It’s a popular option for company 401(k) plans.

Read more: Taking stock: A look at how Americans are investing

Managing an investment portfolio

Once you choose investments that align with your asset allocation, your work isn’t done. You’ll still have to revisit your portfolio regularly and rebalance as needed. Over time, certain assets in your portfolio will grow more quickly than others. As a result, you’ll have to rebalance your portfolio to get it back to your desired asset allocation.

Rebalancing is the process of returning your portfolio to its intended asset allocation. This is often done by selling certain assets and buying others or by pausing purchases on some investments to allow others to grow more.

For example, suppose you have an asset allocation of 70% stocks and 30% bonds. Your stocks are likely to grow more quickly than your bonds. Eventually, your portfolio might reach an asset allocation of 80% stocks and 20% bonds. You’ll have to rebalance to get back to your original 70/30 split.

There are several methods you can use to rebalance your portfolio. First, some people rebalance on a set schedule, while others rebalance when their asset allocation deviates by a certain amount. Once you’re ready to rebalance, you can do so by either selling certain investments and buying others or by pausing your purchases on your overperforming assets until you’ve purchased enough of your underperforming assets to get back to your original asset allocation.

Depending on your investment strategy, you may benefit from automatic rebalancing. Robo-advisors and target-date funds rebalance your portfolio for you.

Factors to consider when building an investment portfolio

We’ve already briefly touched on the three factors to consider when building your investment portfolio, but it’s important that we investigate them further.

Investment goals

Your investment goals are your reason for investing. Perhaps the most common investment goal is retirement. In fact, a tax-advantaged retirement account is the first experience many people have with investing. Other common investment goals may be a college education, a home, wealth to pass down to loved ones, and more.

Identifying your investment goals is an important first step in investing. It gives you direction when building your asset allocation, ensuring the right investment strategy and optimal portfolio performance.

Risk tolerance

Your risk tolerance is your comfort level with risk. Someone with a higher risk tolerance is comfortable taking on more risk for a higher potential reward. Meanwhile, someone with a low risk tolerance would rather accept a lower potential reward if it comes with a lower risk.

In some cases, someone’s risk tolerance is innate. Some people are simply more comfortable with risk. However, someone’s risk tolerance could also be dictated by their financial circumstances. Someone who can’t afford to lose the money they’re investing may, as a result, have a lower risk tolerance.

As you’re building your investment portfolio, it’s important to consider your risk tolerance. Determine whether you’re willing to accept short-term volatility for potential long-term gains.

Time horizon

The final factor to consider when determining your investment profile and asset allocation is your time horizon, which is the amount of time until you hope to achieve your financial goal. For example, if you’re 30 years old, investing for retirement, and hope to retire at 60, your time horizon is 30 years.

Your time horizon has an important impact on your investment portfolio. Generally speaking, the longer your time horizon, the more risk you can afford to take. Meanwhile, the shorter your time horizon, the less risk you can take on. Young investors with long time horizons can generally afford to take on the most risk, while older investors are more likely to prioritize capital preservation over aggressive growth.

Keep in mind that your time horizon will change each year as you get closer to your goal. As a result, your asset allocation may also need to change to ensure your portfolio matches the amount of risk you can afford to take on.

Importance of diversification

As you’re building your investment portfolio, diversification is key. Diversification is the process of spreading your money out over many different assets in your portfolio.2 There are two different ways you can diversify.

First, you can diversify by having several different asset classes in your portfolio, including stocks, bonds, cash alternatives, and alternative assets. You can also diversify by having many different assets within a specific asset class. For example, you can diversify your stock portfolio by having stock from many different companies.

Diversification is critical to reduce risk in your portfolio. It’s the premise of not putting all of your eggs in one basket. If one company you’ve invested in performs poorly, it won’t have a significant impact on your portfolio because it’s just one of many in your portfolio. It prevents a single company from having too great an impact on your returns.

Diversification doesn’t look the same for everyone. Previously, we discussed the different types of stock portfolios, including aggressive, growth, income, defensive, and balanced. Each of those portfolios can be well-diversified while all looking very different.

One of the easiest ways to quickly diversify your portfolio is to invest in mutual funds and ETFs. These funds include hundreds — or even thousands — of underlying securities, meaning you can diversify your portfolio with just one investment. Just make sure your diversified portfolio includes an allocation of stocks, bonds, and other investments that’s appropriate for your goals, risk tolerance, and time horizon.

Read more: Beginner’s guide to portfolio diversification

Tax considerations in portfolio construction

One of the final considerations when building a stock portfolio is the potential tax implications. The government imposes taxes on all types of income, including capital gains, dividends, and interest earned in investment portfolios. There are two key types of taxes you could be subject to:
 

  • Capital gains taxes: Capital gains taxes apply to long-term capital gains — meaning gains on assets you’ve held for more than one year — and some dividends. These gains are taxed at federal income rates of either 0%, 15%, or 20%, depending on your income.
  • Income taxes: Income tax rates apply to short-term capital gains, — meaning gains on assets you’ve held for one year or less — interest, and some dividends. For these taxes, your normal income tax rate applies.

Taxes can eat up a portion of your investment earnings, but there are ways to reduce the amount you’ll owe. One of the best ways to reduce your investment taxes is to invest in a tax-advantaged retirement account like a 401(k) or an IRA. And if you use both a tax-advantaged account and a taxable one, you can be more tax focused by putting your more tax-efficient assets in your taxable account, while leaving your less tax-efficient assets in your retirement account.

If you’re uncertain of the best way to reach your investment goals while also being tax-efficient, consider seeking the help of an investment or tax professional.

Frequently asked questions (FAQs)

How much of your portfolio should be in one stock?

Generally speaking, one stock should make up no more than 5% of your investment portfolio. For example, if you have $50,000 invested, no more than $2,500 should be in one stock. Having too much of your portfolio in a single stock introduces significant risk because if that company performs poorly, so does your entire portfolio.

A situation where it could be common to have a large portion of your portfolio in one stock is if you work for a company that offers equity compensation, such as stock options. If that’s the case for you, make sure the rest of your portfolio outside of your stock options is well-diversified.

How do you rebalance an investment portfolio?

There are two different approaches you can take to rebalance your investment portfolio. First, you can use regular interval rebalancing, meaning you rebalance at certain times throughout the year, which could be annually, semi-annually, or quarterly. Another approach is to use threshold-based rebalancing, which is when you rebalance when your asset allocation deviates from your planned allocation by a certain amount,

How much international stock should you have in a portfolio?

It’s up to each investor to decide how much international stock to include in their portfolio. Some successful investors have no international stocks at all, choosing to invest solely in the U.S. stock market. Others may invest more heavily in international stocks. 

Generally speaking, you could consider having about 20% of your portfolio in international stocks and bonds. Because international markets fluctuate differently than the U.S. market, investing in international securities can provide additional diversification to your portfolio.

Is it risky to own stock?

All investments have a degree of risk. Historically, stocks have outperformed most other investments over the long run.3

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1 Investor.gov, “Stocks,” April 2024.

2 Investor.gov, “Diversification,” April 2024.

3 New York University Stern School of Business, "Historical Returns on Stocks, Bonds and Bills: 1928-2021,” January 2024.

Investing involves risk, including possible loss of principal.

Asset allocation, diversification, and/or rebalancing do not ensure a profit or protect against loss.

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Jeremiah Forrest, CFP®

Contributor

Jeremiah Forrest is a Senior Financial Professional at Empower. A CERTIFIED FINANCIAL PLANNER™ professional, he works with Empower Personal Wealth investment clients and provides a wide range of financial planning services for clients who are enrolled in the Personal Strategy managed asset program. 

The content contained in this blog post is intended for general informational purposes only and is not meant to constitute legal, tax, accounting or investment advice. You should consult a qualified legal or tax professional regarding your specific situation. No part of this blog, nor the links contained therein is a solicitation or offer to sell securities. Compensation for freelance contributions not to exceed $1,250. Third-party data is obtained from sources believed to be reliable; however, Empower cannot guarantee the accuracy, timeliness, completeness or fitness of this data for any particular purpose. Third-party links are provided solely as a convenience and do not imply an affiliation, endorsement or approval by Empower of the contents on such third-party websites.

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