When you reach your 50s, and your retirement is approaching, how would you choose to spend the secured savings you have made so far? The answer is an investment. But, it takes determination and patience to understand and analyze the investment and the risks associated with it. There is an old saying, “Don’t put all your eggs in one basket”, which means you should not invest all of your money in a single asset. This is because the returns on individual shares tend to be more riskier than returns on indices. When an investor starts investing more than two assets, and values do not necessarily move in the same direction at the same time, there is less risk for the investor of his or her collection of investments or portfolio. This concept is also known as diversification. It takes time and careful planning to build a portfolio, and the investor must know that it is possible to quantify the risks and high returns on investment that might yield in the future. Keep reading to find out the parameters of how one can build an investment portfolio for retirement.
What is the Right Time to Build an Investment Portfolio for Your Retirement?
Investment is age neutral and can be made at any point in your life. Warren Buffet, also known as the “Oracle of Omaha”, is one of the richest men on earth, well known for his investment strategies which made him one of the most successful investors in the world. He started his investment by making his first stock purchase at the age of 11. One of his famous rules of investing is, “You shall never invest in businesses you cannot understand”, meaning the investor must be fully aware of where the money is put into. Any person who wishes to build something for his or her retirement can start doing so in their early 20s. When it comes to building an investment portfolio, the investor can start at that age by making alternative investments and evaluating the risk tolerances on them, as the investor would have limited money for the investment. Once the investor reaches 30, there is a potential for diversification of those investments and building a strategy of reducing risk by investing in two or more assets. Then, by the time the investor reaches 40, the focus shifts to investing in assets that are more time-efficient and consider passive income options since the portfolio will accelerate with the increase in income. Finally, the investor, before reaching his or her 60s, can start liquidating all the previous investments made so far.
Approaches for Building Portfolios
The portfolio-building process, according to investment philosophers, is also known as the style of share selection used by them. There are two basic approaches on which the investors focus while building their portfolios i.e., growth and value equity investing.
- Growth Investing – The investor looks into the future potential returns from the firms and identifies the shares whose future returns are expected to grow faster. Growth investors look at the soundness of a firm and the intensity of the firm’s debt obligations to ensure that their investments are in safe hands. Since the firms with higher debt financing do not tend to be beneficial for the growth investors in the market, they consider investing in firms with profit-earning capacity.
- Value Investing – The investors look for firms where the share prices are undervalued in the market. A value investor looks for bargains, unlike a growth investor who focuses on the potential for growth in earnings and dividends. In that way, the value investors are benefited only when they find bargain shares at prices below the firm’s value.
Importance of Portfolio Selection
Portfolio selection is crucial for investors for risk management, maximizing returns on investments, and achievement of other financial goals. In a dynamic market like India, portfolio selection gives the advantage to the investors to adapt their investments to the changing market conditions as they get more exposure to risks, and this helps them in aligning their investments with the changing financial scenario in the market.
Diversification of Portfolio
Diversification of the portfolio is a crucial strategy for investors to widen their investments to different classes of assets, securities, etc., to reduce the risks and expect higher rates of returns in the future. It is important to invest in different sectors of the economy and not stay fixated on one field. The diversification of a portfolio depends on the risk tolerance of an investor. This is because some investors may prefer making investments with higher risks, while others may choose to focus on mere capital preservation. In the long run, investing in a specific classification of assets or securities may not yield good returns to the investors as the market conditions undergo changes, and it becomes necessary for the investors to monitor the values of investment periodically and take measures to diversify their portfolios.
Risks from Diversified Portfolios
Diversified portfolios are less risky for a given level of return than the individual risky assets in the portfolio. The reason for this is the prices of individual assets rarely change by the same amount in the future at any time. Thus, some of the variations in an asset’s price can be diversified by owning another asset at the same time. This gives the investors a chance to eliminate some of the risks associated with individual investments by holding them in a diversified portfolio. Another important point is that as the number of assets becomes large, the total risk of the portfolio decreases.
Conclusion
The decision to construct an investment portfolio is the primary step of your investment journey. Being an investor, one cannot solely depend on high returns from only one section of the investments. There might be several choices for an investor in assets or securities allocation in the market. Thus, diversifying those investments may help them to earn higher returns with lower risks on them. It is necessary to build a strategic portfolio over time and may aim to reduce the impact of market volatility on their portfolios. Once a person retires from a job, all the fruits of his or her labour from years of hard work can be used for building a versatile investment portfolio tailored to their specific needs and goals.
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