Five Steps to Build a Suitable Portfolio

There is more to successful portfolio building than just picking good investments.
By Morningstar Analysts |  10-02-10 | 
 

There is more to successful portfolio building than just picking good investments. Putting together a portfolio of securities is like building a wardrobe. Even if your closet is filled with 'top-of-the-line' attire, it may not be enough. All those components need to work together as outfits. Building an investment portfolio is no different.

In this article, we present a five-step strategy to design a successful portfolio of investments that work together to help you reach your goals. Also, we discuss essential steps for tailoring your portfolio and keeping it in good shape.

Step 1: Create a pattern

Just as a tailor making a suit starts with a pattern, you need a pattern for your portfolio. The tailor's pattern fits an individual of a particular size and shape. Similarly, your portfolio should fit you.

A good fit starts with your investing goal. Maybe you are investing for retirement, for your child's education or for a vacation home. Whatever your goal, it gives you vital information. It tells you how long you will be investing (your time horizon), and how much of your investment you can put at risk. The closer your goal or the less you can afford to lose, the more you should focus on preserving what you have made rather than on generating additional gains.

Step 2: Determine the right asset mix

How much should you put into cash, bonds, and various types of stocks? One rule of thumb is to use your age as a guide. For instance, if you are 33 years old, put 33% of your portfolio into cash and bonds and the rest into stocks.

Some investors would find that figure awfully conservative, though. Others might find that it's too aggressive for their particular goal. Such rules are like buying a 'one-size-fits-all' shirt, sure you can wear it, but does it really suit you? Probably not. Hence, the need to determine what cash/bond/stock mix is right for you. The financial planner can play an important role in helping you determine the right asset mix.

Step 3: Discover what you already own

Maybe you can name all of your stocks and mutual funds off the top of your head and detail how each one performed last week. Good for you. But can you explain how they work together? Which are your core investments? Are you diversified? Do you have a lot of overlap? You must be able to answer those questions before you can see how (or even if) your portfolio fits your pattern.

To figure out exactly what you own, you could buy a financial calculator or investing spreadsheet, obtain the latest fact sheets for your funds and account statements for your stocks, and calculate how much you have in cash, bonds, and various types of stocks. What a job! No wonder several investors don't know what's in their portfolios.

Another (and a more feasible option) is to use online tools like Morningstar's Instant X-Ray instead. This will help you discover your portfolio's asset mix, style-box breakdown, sector weightings, regional exposure, and more.

Step 4: Schedule a time to rebalance

By following the first three steps, you have tailored a portfolio that suits you to a T. You will want to make sure that it continues to fit, though. That requires occasionally rebalancing, or restoring the original pattern. For example, stocks often gain more than bonds or cash. As a result, stocks will probably take up more of your portfolio over time than in your original pattern. Because stocks are riskier investments than bonds, your portfolio is becoming riskier as your stock position rises. That's why it's important to rebalance and restore your portfolio to its original pattern.

When you rebalance, keep your goal in mind. As you get closer to needing the money you have invested, the pattern you originally drew should change. Your portfolio should become more conservative as you approach your goal.

Step 5: Monitor your investments

In addition to rebalancing your portfolio, you need to keep tabs on your individual investments. You need to make sure they are still filling their original roles in your portfolio.

Let's say you are monitoring your mutual funds. What types of things should you look for? Make sure your funds stay in the same in nature; in other words, if a fund's style has changed dramatically, the fund may no longer meet your needs. Examine the fund's performance - is it still competitive? Watch out for manager changes, too.

With stocks, you will want to keep tabs on price, and where that price is relative to the sell target you have determined. Changes at the top matter as well - new management can mean new strategy. Other factors like profitability, financial health, and growth prospects also matter.

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Raghav Garg
Apr 25 2017 09:05 AM
I am getting "The seamless login failed! " <br />while logging in my portfolio .
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