A lot of new investors don’t know the meaning of words like portfolio, portfolio management, etc. An investment portfolio can be defined as the whole group of assets a person has invested in. It can include mutual funds, stocks, bonds, securities, property, gold, and other precious metals, etc. However, usually, people refer to Mutual Fund Portfolios and Stock Portfolios using the blanket term “investment portfolio”.

Contrary to popular belief, investment portfolios need not be a complicated thing. If one’s financial goals are clear, it is possible to build a simple and effective portfolio. Every industry has its own jargon and investing is no different. In financial world investing portfolio denotes total invested assets of an investor.

Investors can construct portfolios aligned to investment strategies by following a systematic approach. Here are some essential steps suggested by wealth management companies for taking such an approach:-

Step 1: Assess/Determine your Risk Appetite

Risk Appetite simply refers to how much risk you are willing to take as an investor. This is not just a function of your own emotional decision but should also be based on your age, income, and expenses. Risk Appetite is broadly broken down into 3 main categories:

1.Conservative – Low market risk + low returns
2.Moderate – Medium market risk + decent returns
3.Aggressive – High risk + high rewards

Step2: Identify Your Goals:

Once risk is identified, the next step is to identify investment Goals. A portfolio should be created by mapping the financial goals to your investments. Financial goals are the dreams which you aspire to achieve and invest accordingly. Goals can be short-term or long-term.  While wealth creation, tax saving, capital preservation and retirement corpus are some of the most common long-term investment goals. Once your investment objectives are in place, the portfolio can be built to ensure that you are on track to realising your aspirations. A goal-based portfolio is always better than investing randomly.

Step 3: Allocate in different assets basis of your risk appetite

While building an investment portfolio, it is important to keep track of asset allocation. Asset allocation is the percentage of each type of investment you hold in your portfolio and is key to achieving optimal diversification. Asset allocation is influenced by factors like:

i) Your returns expectations
ii) Your risk profile
iii) Your investment time horizon.

For example, if you have an aggressive risk profile, are looking to generate high returns, and have an investment time frame of over 10 years, then your portfolio asset allocation could look something like this: 80% to equities, 15% to bonds, 5% to cash or cash equivalents. However, this is a very simplistic view of asset allocation. Ideally, you would consider an entire spectrum of investments and diversify your portfolio across two or three investment options like a stock fund,a bondfund, a mutual fund, and maybe an international stock fund.

Step 4: Avoid Over Diversification

With portfolio management, diversification is often cited as a significant factor in reducing investment risk. However, there is a risk of over diversification, which can create confusion and lead to weaker-than-expected risk-adjusted returns. Financial innovation has created many “new” investment products with old investment risks.The best way to avoid over-diversification is for an investor to keep their portfolio to a manageable level.