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Investing can be a daunting prospect for some, while for others, the expectation of building a portfolio that is profitable when a simple mistake could potentially derail an investor’s entire financial future can make crafting one a tricky art to master. Put into the mix the wide variety of possible assets that you can add to your portfolio, together with the extremely dynamic and ever-evolving investment landscape and you could easily have doubts as to whether you are doing things right.
While there are many ways to get started investing, taking into account some key factors when building your portfolio, as well as getting the necessary support from a professional financial advisor may be just the thing you need to put you on the road to success.
Read along to discover the key factors you need to consider when building your portfolio.
Determining what your investment profile is like is crucial to understanding the kinds of investments that you should include in your portfolio. And bearing in mind that no two people are exactly the same, you need to establish an investment profile that is unique to who you are. As such, your profile should include your goals, your goals’ time horizon, the type of returns you’re looking for, how easily you might need to access the money and your appetite for risk.
Whether you’re looking to invest for a short-term goal such as investing for your children’s education or long-term objective like investing for retirement, your portfolio cannot be crafted without having clearly defined goals.
Are you planning to accumulate a substantial amount of funds for retirement? If the answer to this question is yes, then you may have 20 or even 30 years on your time horizon. Generally speaking, short-term is any period between one and three years, whereas medium-term is a period of four to nine years. In contrast, a time frame that exceeds 10 years is considered long-term.
Are you looking to boost your monthly income or perhaps grow your initial investment? If receiving a short-term income from your investment is important, ideally invest in assets that will help you earn a guaranteed return. In contrast, if you would rather grow your nest egg and do not need income for the short-term, consider investments like shares.
Liquidity refers to how easily and quickly you can convert your investments into cash before the end of the investment period. An investment with high liquidity means that you can get your investment at any point in time, which is usually the case with stocks for example. On the other hand, investments with low liquidity may take longer to convert into cash since finding an appropriate buyer and complete the sales process may take more time. There are also investments which are considered illiquid, in the sense that you cannot get your money until a certain date or event.
Risk and reward are an investor’s balancing act. In investing terms, risk refers to the degree of uncertainty or possible financial loss you take on when you make any type of decision that involves your money. As the common saying goes -the higher the risk, the higher the returns – however, it’s important to remember that the higher the risk, the higher also the chances of your investments losing value, fluctuating in value and at times, even failing entirely. Conversely, keeping your money in cash may also prove to be a risk as inflation will slowly decrease your purchasing power.
There are generally two types of risks you may encounter when it comes to investing. One is volatility and the possibility that the value of your investment will go up and down, while the other is performance – the likelihood that the investment could fail, in which case you may lose money or it may end up giving you lower returns than expected.
Here are four factors that can impact your tolerance to risk:
Here is a brief snapshot of each asset classes’ main characteristics:
Stocks – these are a type of investment that represents an ownership share in a specific company. Investors buy stocks they believe will go up in value overtime, however, the opposite may also take place. Choose stocks that satisfy the level of risk you want to carry and make sure you consider things like sector, market cap and stock type.
Bonds – a fixed-income instrument that represents a loan made by an investor to a borrower, through bonds companies and countries borrow money from investors. These typically pay the funds back at a fixed date, while throughout the lifetime of the bond, investors are paid interest. When deciding which bonds to invest in, take into consideration the bond type, its credit rating, the coupon and its maturity. Here is a more detailed explanation of what bonds are and how they work.
Looking to gain a better understanding of fixed income securities? Have a look here.
Funds – funds offer investors a means of pooling money together with other individuals and invest indirectly in an assortment of assets, enabling investors to buy units within a company. In addition, they are managed by professional and experienced fund managers, offering investors some added peace of mind.
ETFs – investing in exchange-traded funds can be a good way of mitigating any risk associated with stocks, since ETFs hold a collection of stocks from a wide variety of companies.
Linked to the above is the idea of deciding whether you are looking to build a passively invested portfolio or an actively invested one. Active investing is a hands-on approach that aims to beat the market or outperform a certain standard benchmark. The portfolio manager takes full advantage of short-term price fluctuations and conducts an independent assessment of each investment’s worth so that they can select the most attractive options. Passive investing is a more balanced approach which aims to match the broad market performance and focuses on the long-term, as well as on a buy-and-hold approach, while it resists the temptation to react or anticipate the stock market’s next move.
Ideally you should strive to create a balance between active and passive investments since including both options can be highly complementary and can help you navigate risks more effectively.
Have a look at the main differences between active and passive investing.
Factors such as your current financial situation, your future needs for capital and your risk tolerance will determine how your investments should be allocated among different asset classes. Your asset allocation will also depend on whether you are a conservative, moderate or an aggressive investor, which in turn will be defined by your risk profile mentioned earlier on. With this in mind, it is important to understand your risk tolerance, your comfort levels when it comes to the fluctuations in the value of your portfolio and other similar factors.
As a general rule of thumb, the more risk you can bear, the more aggressive you can afford to be and therefore, you can allocate a larger portion to equities and less to bonds and other fixed-income securities. If you cannot take on too much risk, then your portfolio will have to be more conservative.
From hedging against market volatility to increasing your exposure and helping you preserve your capital, there are several benefits to diversification. A risk management strategy whereby the capital is allocated in such a way that reduces the exposure to any one particular instrument, to achieve diversification you must invest in a wide variety of investments. In this manner, if one investment fails, another one will balance things out and increase your chances of good returns. What’s more, diversification comes in various forms. At an asset class level by investing in multiple asset classes such as stocks and bonds, however, diversification can also take place within asset classes by diversifying, for example, your sector exposure within your equity exposure.
Read through this article about the importance of investment portfolio diversification.
Tracking the performance of your investments is imperative, since doing so will ensure that you are on track to achieving your financial goals. Is your portfolio underperforming or not meeting your expectations? Then consider whether this is due to short-term or long-term factors, reasons that are beyond your control like a wider economic slowdown or whether this underperformance is perhaps temporary.
Having said that, avoid being overly hasty in responding to underperformance, since some every now and again, particularly when it comes to equities, is expected. Taking any action in this situation may mean that you miss out on their recovery. Also, you must invest regularly since doing so is a sure proof way of achieving your goals, while it can help you make the most of compound interest.
At its very basis, the purpose of any portfolio is one – to make money. This means that you need to ensure that the portfolio you create is profitable and that it remains so. Here are some ways to measure your portfolio’s performance.
A financial ratio used to calculate the benefit an investor will receive in relation to their investment cost, the ROI is most commonly measured as net income divided by the original capital cost of the investment. Naturally, this will also depend on the types of investments you hold together in your portfolio. The higher the ratio, the greater the benefit earned.
Measuring your risk is also an important element to your portfolio’s success since risk and reward are two sides of the same coin, while your appetite for risk will condition and at times, even dictate the rewards. However, measuring risk can be a very complicated feat and there are several ways to measure it. From standard deviation to beta and value at risk (VaR), unless you are a seasoned investor, your best bet to measuring risk and overall, your portfolio’s profitability is to speak to an experienced financial advisor.
Financial markets change frequently and this is the primary reason why you need to review your portfolio every so often. If you fail to do so, over time you may notice that your chosen asset allocation mix has changed due to price fluctuations in the market. For example, if you had an investment portfolio with 60% stocks and it increased to 65%, you may want to either sell some of your stocks or invest in other asset classes until you stock allocation returns back to 60%. The act of realigning the weighting of your portfolio’s assets is called rebalancing and its purpose is to maintain your desired asset allocation based on your risk appetite.
Building your investment portfolio can be a daunting task, particularly if you are new to investing, while even if you have long established your portfolio, monitoring it regularly may be time consuming. No matter how engaged you want to be with it, the safest and more convenient option is to get professional help. With the aim to consistently service clients in an honest and personalised manner, Calamatta Cuschieri’s financial advisors are committed to providing a high value and comprehensive service, with clients’ best interest in mind. As a result, they can make sure that your investment portfolio is in line with your goals, timeline and willingness to take on risk.
Once you have considered the above pointers, you must then decide on the investment strategy you should employ. Not sure how to go about doing that? Here is how to choose the right strategy for your portfolio.
Get in touch with us today to speak to one of our financial advisors.
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Calamatta Cuschieri Investment Services Ltd is licensed to conduct investment services business under the Investments Services Act by the MFSA and is also registered as a Tied Insurance Intermediary under the Insurance Distribution Act.
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