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I hear the word “portfolio” tossed around frequently. And, I glean from my readings and conversations that a diversified portfolio is desirable as is a large investment portfolio.
Here is a primer on portfolio and related terms:
- Portfolio Definition: A portfolio is a collection, usually one that has been developed or acquired over time. In investing, my portfolio is a collection of the investments I hold.
- Investment Portfolio Components: An investment portfolio can be comprised of a single stock, a single bond, or a single real estate property. Or, it could be comprised of hundreds of stocks, mutual funds, bonds, and a real estate investment trust (REIT) fund.Here are investments that may be part of a portfolio:
- Individual Stocks
- Individual Bonds
- Mutual Funds (comprised of stocks only, bonds only, or a mix of stocks and bonds)
- ETFs (comprised of stocks only, bonds only, or a mix of stocks and bonds)
- Individual Real Estate Properties
- Real Estate Investment Trusts (REITs)
Whether I own one, some, or all of these types of investments, I have an investment portfolio.
- Portfolio Asset Allocation: How my portfolio is allocated among various components is its asset allocation. There are many ways to consider an allocation. At a basic level, assets could be divided into equities (stocks), fixed-income instruments (bonds) and cash equivalents. These categories are asset classes.But I could also (and probably should) classify investments according to finer distinctions or asset class categories. Stocks could be divided into U.S., international developed, and international emerging; sliced further into U.S. large-cap growth, U.S. large-cap value, U.S. small-cap growth, U.S. small-cap value, etc.; and/or classified according to industry or sector.
- Purpose of Asset Allocation in a Portfolio: The purpose of proper asset allocation is to manage portfolio risk while achieving a given expected investment return by holding diverse asset classes. These concepts of asset allocation and diversification are part of Modern Portfolio Theory (MPT), which many financial advisors consider when building client investment portfolios.Historically, different asset classes deliver different investment returns at different times. When returns move similarly, they are positively correlated; when they move differently, they are negatively correlated. This correlation is not always distinctly positive or negative; rather correlation falls on a continuum.Ideally, a portfolio constructed with negatively correlated asset classes will consistently deliver desired investment returns, fluctuating within a certain acceptable range, barring calamity in all areas of the economy.
- Investment Portfolio(s): Typically, when I think of an investment portfolio, I consider my 401(k), IRA rollover, Roth IRA, taxable brokerage accounts, 529 Plan account, Coverdell account, personal residence, rental properties, etc.Financial advisors typically urge investors to view an investment portfolio as a whole (that is, look at all of my accounts together). This approach is useful for evaluating portfolio diversification and tax efficiency.For example, while conducting a holistic review, I might notice that an advisor's managed portfolio includes employer's stock, which is also heavily represented in my 401(k) plan. As a result, I may ask for this stock to be excluded from the outside portfolio or I might opt to purchase index funds for the employer-sponsored plan instead of company stock. In this way, my holdings won't be heavily concentrated in one stock, protecting me if the company experiences financial problems.
I also like to evaluate individual accounts: some have a specific purpose relating to diversification; others allow me to apply investment strategies to a portion of my portfolio. For example, my husband's Roth 401(k) currently holds a large international index fund to provide diversification to our retirement portfolio. Another account, an IRA rollover, holds commission-free funds based on a momentum investment strategy.
So, when I think of my investment portfolio, it's useful to consider each account independently as well as how each account fits within the entire investment portfolio.
- Types of Investment Portfolios: I've read about investment portfolios that are designed to match an investor's goals, preferences, and/or investing style. For example, Investopedia describes aggressive, defensive, income, speculative, and hybrid portfolios in an article on popular portfolio types. Investment firms describe their basic offerings as “core” portfolios, which are often a diversified mix of index funds.If an investment portfolio is labeled, pay attention to the investment approach being offered. For example, TradeKing offers core portfolios consisting of broadly diversified funds as well as momentum portfolios that are designed to contain investments that are currently outperforming the market.
- Investment Portfolio Analysis Tools: My brokerage firm, robo-advisory firm, or third-party source of investing information may have investment portfolio tools that can help me to build, balance, rebalance, and manage my investment portfolio. Generally, these tools provide me with an ideal or optimal portfolio and then make recommendations or give me ideas on how to bring my current holdings into alignment with the ideal portfolio.Many of these tools are useful. But be wary of those that blanketly recommend selling an entire portfolio and buying new ETFs, mutual funds, and stocks that may carry higher fees and risk.
- Portfolio Management: I may want to manage my portfolio on my own or hire a registered investment advisor (RIA) to manage my investment portfolio. Based on a Fidelity report, many millionaires and deca-millionaires share the responsibility of portfolio management with outside advisors. Typically, I'll pay an assets under management (AUM) fee on the investments that are being actively managed if I decide to outsource portfolio management.
Simply put, my investment portfolio is my collection of investments among various accounts, whether stocks, bonds, cash, or real estate. Whether studying the whole or components of a portfolio, there are many ways to view my investments and ensure their suitability to my personal and financial goals.