What is an investment portfolio?
An investment portfolio is a collection of financial assets like stocks, bonds, commodities, mutual funds, ETFs (exchange-traded funds), and more. Many confuse an investment portfolio as a physical object, but it's a concept that refers to a group of investments for both physical and digital assets. People hold investment portfolios to earn profits on their initial deposits. Having an investment portfolio allows you to reduce the risk of your combined assets by diversifying your portfolio.
For example, if you invest in gold, real estate, cryptocurrency, and shares of a multinational company, you have four different types of investments in your investment portfolio. If the price of one of these assets falls, you still have the other three to keep your overall investments relatively balanced. But there are many more asset classes than just real estate, cryptocurrencies, and company shares.
Let’s look at the different kinds of assets you can find in an investment portfolio.
What to find in an investment portfolio?
Assets in an investment portfolio are known as asset classes. The investor or financial adviser must ensure that a healthy asset combination exists to preserve balance, promoting capital growth with minimal or controllable risk. Each asset class has a different risk level, so some asset classes fit certain portfolio types better than others. An investment portfolio may include the following asset classes:
Stocks
Stocks are the most popular type of asset class in an investment portfolio. They’re used to describe a percentage or share of a public corporation. It signifies that the person who owns the stock has a stake in a corporation, and the number of shares they hold determines their position in the company.
Stocks become an income source when a company turns a profit. The company then distributes a percentage of those gains to stock owners as dividends. Additionally, once stocks are purchased, the owner can sell them at a higher price based on the issuing company's success.
Bonds
When you buy bonds, you loan funds to the bond issuer, which can be a large corporation, an agency, or the government. Bonds have maturity dates that indicate repayment. Investors repay bonds with the original amount used to purchase the bond plus an interest rate. Bonds aren't as risky as stocks, but their potential profits aren't as much either.
Mutual funds
A mutual fund is a type of asset class that pools multiple investors' money into one basket to generate investment returns. There are several types of mutual funds. The expected benefit of purchasing mutual funds is portfolio diversification, as they allow you to invest in a fund with multiple investments like stocks and bonds. Mutual funds tend to carry less risk than stocks.
But who manages mutual funds? A fund manager is responsible for some. These managed mutual funds are costlier and don't necessarily outperform index funds, which are mutual funds without a manager.
Index funds and ETFs attempt to replicate the performance of stock market indices like the S&P 500. These investment vehicles are often cheaper than managed mutual funds, as you don't need to pay a professional fund manager to handle the fund's assets. However, ETFs differ from index funds. While you can trade ETFs on stock exchanges during trading hours, index funds can only be exchanged after trading hours.
Alternative investments
Alternative investments are another asset class you can incorporate into your investment portfolio. They’re usually assets with high growth potential––like gold, oil, art, real estate, cryptocurrencies, and even wine––and don't have trade volume as high as traditional stocks and bonds.
Risk & reward
The general perception in the investment world is that risk equals profit––the higher the risk of the asset, the higher the profit potential. If the investor plays it safe by investing in lower-risk assets, the profit potential also tends to reduce. However, the greater the risk the greater the chance that the investor loses more. This is known as a risk-reward ratio.
It’s the criterion investors use to decide which assets they want to invest in and add to their investment portfolios. As different types of assets carry different levels of risk, some asset classes may be better suited to other portfolios.
Types of investment portfolios
Portfolios come in different types depending on their asset allocation risk and asset classes their investors choose. Here are the different types of portfolios:
- Aggressive portfolio: Aggressive portfolios, also called capital appreciation portfolios, are suitable for younger individuals who have a higher risk tolerance and want to develop their assets quickly. They often contain more volatile assets such as growth stocks (corporations stocks that show promising potential but aren't yielding profits yet), domestic and foreign shares, and speculative assets (like cryptocurrency).
- Speculative portfolio: Investors with speculative portfolios go further from aggressive portfolios and take higher risks with their investments. These involve taking “bets” on potentially profitable investments.
- Growth portfolio: A growth portfolio seeks to foster development by taking more significant risks, such as investing in rising sectors. These often provide higher potential returns, although this comes with greater risk. Growth investing can entail investing in growing companies and bigger, more established businesses.
- Conservative portfolio: Conservative portfolios, also known as defensive or capital preservation portfolios, limit risk to a bare minimum to protect investor funds. This is possible when investors own stocks and bonds. Conservative portfolios are prevalent among people who are approaching retirement and are apprehensive of losing money.
- Income portfolio: Income portfolios generate consistent income streams from various asset classes, especially individual stocks and bonds. Elderly individuals and retirees tend to choose income portfolios to provide a steady cash flow for retirement income.
- Socially responsible portfolio: Socially responsible portfolios contain environmental, social, and governance (ESG) investments and enable investors to make profits while sponsoring a charitable cause. Investors can create these portfolios for any risk level. One of the key advantages of this portfolio is investments in stocks and bonds that attempt to counteract environmental concerns and promote equality and diversity.
- Value portfolio: Value portfolios contain inexpensive assets that investors buy to benefit during negative financial periods. They’re useful when companies are struggling and the economy is unfavorable for profitability. In these situations, investors look to buy shares from working companies at reduced prices well below financial market value. When the economy stabilizes, the investor sells these shares for a profit, generally looking at short-term value.
- Hybrid portfolio: Hybrid portfolios are a combination of asset classes, including stocks, bonds, and mutual funds. They integrate assets with a higher risk-reward ratio with other asset classes that are safer investments with higher stability.
Crypto in investment portfolios
Cryptocurrencies have grown in popularity as an alternative investment option among investors. The Winklevoss twins, famously known for their involvement with Facebook, saw success in 2017 with their Bitcoin investments after they became the first Bitcoin billionaires. The twins went on to form their own cryptocurrency exchange in Gemini.
This shows us the high-risk, high-reward potential that cryptocurrencies have. Traditionally, investors have stuck with tried-and-tested assets like stocks and bonds. However, alternative assets have opened up a world of options and increased the accessibility of this asset class.
Not only do cryptocurrencies offer an inflation hedge and increase portfolio diversification, but they also provide more people with opportunities to invest in an asset class that could pay huge dividends to those willing to take the risk that comes with crypto assets.
Wrapping up
The objective of any investment portfolio is to increase one's wealth. While it may sound cliché, putting all your eggs in one basket might be detrimental to your portfolio, especially in the crypto world. That’s where investment portfolios come in; they help diversify your portfolio and help maintain a healthy risk-reward ratio by preventing too many potential losses. A good mix of diverse asset classes includes stocks, bonds, mutual funds, alternative assets, and Roth individual retirement accounts (Roth IRAs).
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