“Don’t keep all your eggs in one basket” is an age-old adage that holds in most strata of our lives. And when it comes to your investment endeavours, it would be dangerous to invest all your funds in a single asset, say real estate, fixed deposit, or any other. This is why most investment experts suggest focusing on an investment portfolio, be it a stock market portfolio or other instruments. This article discusses the advantages of portfolio investment.
What is Portfolio Investment?
An investment portfolio is an assortment of investable assets like stocks, bonds, cryptocurrencies, etc. These are divided into a proportion that caters to the investor’s risk propensity. It is a virtual basket that considers the following:
- Your investment goals
- Your risk profile
- When do you want to encash the amount invested?
Types of Portfolio Investments
Portfolio investment comes in several forms and types:
- Growth Portfolio
The reason behind creating such a portfolio is to grow your capital at a significant pace. It comes with taking higher risks while investing in companies and instruments that are beginning to grow and have a considerable upside. A substantial portion of funds in the growth portfolio goes towards young financial instruments that can possibly turn into multi-baggers in the future.
2. Value Portfolio
Here, the focus is to find and invest in undervalued instruments. It means that the investor focuses on figuring out the asset’s intrinsic value and buying only those trading around what they are worth. As a result, these investment portfolios come with lower risks and perform well in a bearish market. While the returns may not be as high as growth portfolios, these ensure continual growth for the investor.
3. Income Portfolio
Income portfolios are a substitute for pension funds and similar funds that offer a periodic payout to investors. Here, the focus is on investing in assets with a proven dividend record instead of mere capital appreciation. These ensure regular passive income to the investor while being comparatively risk-free.
What are the Components of Portfolio Investment?
Today, there are myriad investment instruments available at an investor’s disposal. Each of these asset classes has its set of characteristics and risk factors. For example, a debt portfolio has low-risk assets but entails limited returns, whereas a stock market portfolio carries a higher risk and return perspective comprising shares of several companies.
Here are some of the asset classes that comprise an individual’s portfolio investment endeavour:
- Equity: This represents ownership in a company. When you own stock in a company, you own a small part of that company
- Bonds: These are essentially loans that investors give to governments or companies. When you buy a bond, you’re lending money in exchange for regular interest payments and the original amount will be paid back after a specific time period
- Mutual Funds: These are pools of money collected from many investors to invest in stocks, bonds, or other assets. They’re managed by professionals who make decisions on where to invest the pool of money collected from many investors
- Real Estate Investment Trusts (REITs): Investors can access the real estate market indirectly through REITs, which are companies owning and managing income-generating properties
- Equity-Traded Funds (ETFs): Similar to mutual funds, ETFs pool money from investors to buy a collection of assets. However, ETFs trade on stock exchanges like individual stocks, offering more flexibility in buying and selling throughout the trading day
- Alternative Investments: These cover a wide range of assets outside of traditional investments like stocks and bonds. They can include commodities (like gold or oil), hedge funds, private equity, or even cryptocurrencies. They tend to offer different risk and return profiles compared to traditional investments
The investor invests in a mix of these depending on several factors, such as risk propensity, investment tenure, comfort, and more.
Advantages of Portfolio Investment
The advantages of portfolio management are multi-faceted, especially if you are undertaking a long-term investment approach. Investing in the traditional world was about parking most of your funds in a handful of asset classes with similar characteristics. For example, our previous generation was obsessed with fixed deposits.
Thankfully, with portfolio investment coming at the forefront, things have started taking a different turn. Here are its advantages:
- Risk mitigation
The basic idea of creating a portfolio is to reduce risk while averaging potential returns. It means that while in some years the average returns of individual assets you would have otherwise invested in would be higher, your portfolio would offer robust resistance during difficult times and offer steady returns.
- Diversification
A well-thought-out investment portfolio consists of a plethora of asset classes unrelated or negatively related to each other. For example, if someone has an equity-heavy portfolio, having a small percentage of gold would cater well to mitigate their risk. The importance of portfolio diversification lies in its ability to combat volatility with ease.
- Systematic approach
The basic criterion for the best investment portfolio is to have a systematic approach throughout. For example, if you are a value investor, you should not invest in growth-based companies all of a sudden without understanding the repercussions. An investment portfolio is created and regularly assessed to keep the risk factor in check and also the performance of the assets it encompasses.
- Higher immunity to external crisis
In most cases, managers do not tinker much with the investment portfolio once created. While they look to rebalance every few months, there is a slight chance of massive upheavals. Most of the time, you will find the weights of different asset classes tweaked to ensure optimum returns for the investor. It is because the assets are carefully chosen to counter external risks and stand the test of time.
- Great for capital building or passive income
No one can guarantee that an asset will generate an X% return every year starting tomorrow. While it is easier for debts, it is improbable for equity. So investors must bet on more than one quality asset to ensure the final product meets their earnings expectations, be it capital appreciation or periodic dividend payout.
Disadvantages of Portfolio Investment
Below are a few of the disadvantages of portfolio investing:
Higher Transaction Cost
Frequent buying and selling of various assets within the portfolio can lead to transaction fees. These transaction costs cover brokerage fees, commissions, and charges for trading securities. They can lower your investment returns, making your portfolio less profitable. Keeping these costs low is crucial to boost profits and manage your investments better.
Market Downturns
Even a well-diversified portfolio might suffer during widespread market declines. Certain economic conditions can affect diverse assets simultaneously. During this time, the prices of many investments fall, reducing the worth of the portfolio. This simultaneous decline illustrates that while diversification helps mitigate risk, it doesn’t fully shield portfolios from the impact of extreme market instability.
Over-Diversification
Over-diversification happens when a portfolio contains an excessive number of different investments. While diversifying is good to spread risk, having too many stocks can limit potential gains. It dilutes the impact of strong-performing assets across the board. Instead of enhancing safety, over-diversification might reduce overall portfolio performance by making it harder for high-performing investments to significantly boost returns. Balancing diversification to manage risk without excessively spreading investments is crucial for optimal portfolio performance.
FAQs
A good investment portfolio optimizes the potential returns while matching the customer’s risk profile. For example, let us consider an investor with a medium risk profile. In such a case, the portfolio could have a balance of blue-chip stocks and debt funds for maximum impact.
We do not have a time machine to guarantee the future performance of an asset. So it is always wise to bifurcate our funds into a myriad of assets to protect your capital while ensuring steady growth even during difficult times.
A stock portfolio is a basket of equity stocks. A good stock portfolio could have around 20 to 30 companies that investors believe would give them good returns. The selection of such companies is often based on the investor’s risk profile and growth expectations.
In most cases, the instruments chosen for a portfolio are to help reduce the risk quotient to the minimum. So it is unlikely that your risk factor will increase if you build a portfolio.
