To understand how to build a portfolio, we need to understand what the term means and what it implies. This is necessary to understand what role a portfolio plays. A portfolio is actually a type of briefcase. No, seriously, the original meaning of the word is simply a bag designed to carry documents in. It became associated with investments because in the early twentieth century, stockbrokers would keep each client's share certificates in a separate portfolio. From thereon, the word gradually came to mean any kind of collection of documents. In finance, it specifically means the investments held by an investor, generally all the investments that an investor has.
However, the word's meaning in personal finance has evolved a great deal. A portfolio is a lot more than a collection. For individuals, the best way to plan their investments is to have a separate portfolio for each financial goal.
Different mixes of funds, stocks and other assets lead to different risk levels and different gain expectations. Most people find it difficult to match these to what they want. If you're asked, "What is your risk level?" you'll probably give an answer of some sort but it will just be your gut feeling.
However, if you think of specific financial targets and think of the money needed for them, then you will be able to answer questions about risk and returns precisely. For example, you'll need money for your daughter's higher education after three years. You'd like to buy a house at least ten years before retirement. You'd like to go on a vacation to Europe after two years. You'd like `2 lakh to always be available for emergencies.
Each of these goals is very precise. The risk you can take with it, as well as the amount of money needed can be quantified quite precisely. Therefore, it is relatively easy to decide what kind investments should be made for each of them. Each individual must have many portfolios, one for each financial goal. The other important thing is that a portfolio is not simply a collection. It has different parts that fit together in specific roles and complement each other.
With experience, you'll learn the basics of constructing a portfolio as well as learn about some model portfolios.Having a separate portfolio for each financial goal gives you the best chance of fulfilling them.
Sketch is sourced from Carl Richards of behaviourgap and is used with prior permission of the creator. They are subject to copyright.
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