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The term "financial portfolio" might conjure up images of the super-rich lounging on their yachts, sipping Dom Perignon while complaining about capital gains taxes. But if you have a retirement account such as a 401(k) or IRA, you've got a portfolio too.
A financial portfolio is a collection of assets an individual owns, typically including stocks, bonds and cash. Having a range of different assets in your portfolio can help protect you from financial ups and downs. Here's what you should know about building a financial portfolio that works for you.
What Makes Up a Financial Portfolio?
The three primary asset categories (or asset classes) in most portfolios are stocks, bonds and cash.
A share of stock equals a percentage of ownership in a publicly traded company. As the company's value rises and falls, so does the value of your stock. There are several ways to purchase stocks.
- You can buy and sell individual stocks online using a robo-advisor or purchase them through a brokerage account and some 401(k)s or individual retirement accounts (IRAs).
- If you work for a publicly traded company, your employer may offer you stock options, which give you the right to purchase stock in the company.
- You can also contribute to an exchange-traded fund (ETF) or mutual fund that invests in a variety of stocks. Equity funds and index funds are funds that invest solely in stocks; target-date funds and asset allocation funds are funds that invest in a range of asset classes, including stocks. Retirement accounts such as 401(k)s and IRAs typically include mutual funds and ETFs in their investment choices.
When you buy a bond, you're essentially lending money to a government, municipality or corporation. In return, you get your money back—with interest—after a certain amount of time, known as the bond's term or maturation period. Bonds typically have terms from one to 30 years.
In general, bonds are a low-risk investment. However, some bonds are safer than others. At the low-risk end of the spectrum, Treasury bonds are issued by the federal government and backed by its full faith and credit. At the higher-risk end are a type of corporate bond called high-yield or "junk" bonds. In return for higher risk, these bonds may deliver higher returns than most bonds.
Cash and Cash Equivalents
Cash and cash equivalents are the safest type of asset in a portfolio, but generally have the lowest rate of return. This asset class includes the following.
- Savings accounts are a good place to put money you need for short-term goals.
- Money market accounts combine features of a savings account and a checking account. They generally earn higher interest rates than standard savings accounts, but may also allow you to write checks so it's easier to access your money.
- Certificates of deposit (CDs), available from banks and credit unions, let you invest a certain amount of money until the CD matures—typically in six months to five years. At that time, you'll receive the amount you invested, plus any interest earned. CDs usually earn higher interest rates than savings or money market accounts. The tradeoff: If you need to access the money before the CD matures, you'll pay a penalty.
- Treasury bills (T-bills) are very short-term investments with maturity periods ranging from a few days to 52 weeks. T-bills don't earn interest; instead, you purchase them at a discount on their face value and receive their full face value at maturity.
Types of Financial Portfolios
One person may have multiple financial portfolios. For example, you might have a retirement account, an investment portfolio and a real estate portfolio that could include rental properties you own or investment in a real estate investment trust (REIT). High-net-worth investors might have a portfolio of investments in businesses, such as angel investments or initial public offerings (IPOs).
Depending on your needs and goals, your financial portfolio may take many forms. Some of the most common are:
- Aggressive or growth portfolio: This type of portfolio aims for growth by focusing on stocks with long-term potential. Such a portfolio is more appropriate for younger investors, who have more time to recover from potential losses.
- Moderate or balanced portfolio: Investors seeking a balance between growth and security may choose a moderate portfolio, which typically includes 60% stock and 40% bonds.
- Conservative or income portfolio: Investors near or in retirement who want to focus on generating income with minimal risk may weight their portfolios toward investments such as bonds and dividend-yielding stock, along with some cash equivalents.
- Target date funds: Also called lifecycle funds, these are mutual funds designed to rebalance as you get closer to retirement. The fund invests more aggressively the further you are from retirement and gradually invests more conservatively as the date gets closer.
- Socially responsible portfolio: Investments related to the environment, social issues and corporate governance (ESG) support environmentally and socially responsible businesses. Many mutual funds and ETFs are devoted to ESG companies.
How to Build a Financial Portfolio
Ready to start building your financial portfolio? Here's how.
- Contribute to an employer-sponsored 401(k). Company-sponsored retirement plans generally have fund advisors you can consult for advice on selecting investments. Experts typically advise putting 10% to 15% of your gross income into a retirement plan. Some employers match your contribution up to a certain percentage of your income, boosting your savings even more.
- If you don't have an employer-sponsored retirement plan, you can open an IRA with a bank, credit union or brokerage. You can also use a robo-advisor, an automated platform that takes information you provide about your financial goals to select investments for you. Robo-advisors charge significantly less than flesh-and-blood financial advisors.
- Want more personalized guidance? You can hire a financial planner or investment advisor to guide your investing strategy and handle your investments for you.
When building your financial portfolio, consider:
- Your financial goals: These include both long- and short-term goals. Long-term goals may include saving for retirement or a child's college fund. Short-term goals might include saving to make a down payment on a home in a few years.
- Your risk tolerance: Everyone has a different appetite for risk. You'll also be less able to recover from risky investments the closer you get to retirement.
- Your age: Younger investors have a longer timeline in which to recover from losses, so they can typically take bigger risks with their money than older investors who need to tap into their investments to live on.
- Your budget: Strike a balance between investing for the future and meeting today's financial responsibilities such as building an emergency fund and paying down debt.
- Asset allocation and diversification: Allocating your investments across different asset classes (such as stocks and bonds) is one way to reduce risk. However, you also need to diversify your investments within asset classes. For example, investing in mutual funds that buy stocks from different industries, different countries or different sizes of businesses helps ensure you aren't putting all your eggs in one basket.
Build a Foundation for Your Financial Future
As you think about developing a financial portfolio, don't forget to build an emergency fund you can draw on if you lose your job or face a big, unexpected expense. Stash this cash in a money market or traditional savings account so it's easily accessible should you need it. Working to pay down high-interest credit card debt will free up cash you can use to build your portfolio.
Good credit can help you access loans, credit cards and other financial resources both now and in the future. Check your credit report and credit score regularly and consider signing up for free credit monitoring from Experian to get alerts of changes in your credit score.