Portfolio Construction
Building your investment mix
Category: Investment Strategy
Difficulty: Beginner
Definition
The process of deciding how to divide your money across different types of investments to match your goals and risk tolerance.
The Basic Questions
Before building a portfolio, ask yourself:
- What are my goals? (retirement, house, kidsā college)
- When do I need the money? (next year vs. 30 years)
- How much risk can I handle? (emotionally and financially)
- How much money do I have to invest?
Simple Portfolio Building Steps
Step 1: Set Your Goals
Be specific about what you want: - Retirement: Need money in 30 years - House down payment: Need money in 5 years - Emergency fund: Need access anytime - Kidsā college: Need money in 15 years
Step 2: Choose Your Asset Mix
Basic allocation decision: - Stocks: For growth (higher risk, higher potential return) - Bonds: For stability (lower risk, lower return) - Cash: For safety and emergencies
Step 3: Pick Your Investments
Choose specific funds or stocks: - Index funds: Easy diversification - Individual stocks: If you want to pick companies - Target date funds: Professional management - ETFs: Tradeable index funds
Common Portfolio Allocations
Conservative (Low Risk)
Good for: Near retirement, need money soon, low risk tolerance - 20% stocks, 80% bonds/cash - Focus on preserving money - Lower expected returns - Less volatility
Moderate (Medium Risk)
Good for: Middle-aged, balanced goals, moderate risk tolerance - 60% stocks, 40% bonds - Balance of growth and stability - Moderate expected returns - Some volatility
Aggressive (High Risk)
Good for: Young investors, long time horizon, high risk tolerance - 80-100% stocks - Focus on maximum growth - Higher expected returns - High volatility
Age-Based Portfolio Rules
The ā100 Minus Your Ageā Rule
Simple guideline: - Age 30: 70% stocks (100 - 30), 30% bonds - Age 50: 50% stocks (100 - 50), 50% bonds - Age 70: 30% stocks (100 - 70), 70% bonds
Why it works: Older people have less time to recover from losses
Modern Updates
Some experts now suggest ā110 or 120 minus your ageā: - People live longer now - Need more growth for longer retirements - Age 30: 80-90% stocks, 10-20% bonds - Age 50: 60-70% stocks, 30-40% bonds
Simple Portfolio Examples
Three-Fund Portfolio
Popular with index investors: - 60% Total Stock Market Index (U.S. stocks) - 30% International Stock Index (foreign stocks) - 10% Bond Index (stability)
Two-Fund Portfolio
Even simpler: - 80% Total World Stock Index (everything) - 20% Bond Index (stability)
One-Fund Portfolio
Simplest possible: - 100% Target Date Fund (auto-adjusts over time) - Perfect for retirement accounts - Professional management included
International Diversification
Why Go Global
Benefits of owning foreign stocks: - Different economies: When U.S. struggles, other countries might do well - Different companies: Access to businesses not available in U.S. - Currency diversification: Reduces dollar-only risk - More opportunities: Bigger investment universe
How Much International
Common allocations: - Conservative: 10-20% international - Moderate: 20-40% international
- Aggressive: 30-50% international - Market weight: About 40% (matches global market size)
Portfolio Construction Mistakes
Over-Complication
Making it too complex: - Buying 20 different funds - Trying to time different asset classes - Constantly adjusting allocations - Analysis paralysis
Under-Diversification
Not spreading risk enough: - Only buying U.S. stocks - Concentrating in one sector (tech, healthcare) - Owning too few companies - Ignoring bonds completely
Emotional Allocation
Letting feelings drive decisions: - Loading up on stocks after theyāve done well - Avoiding stocks after market crashes - Changing strategy based on recent news - Following hot investment trends
Keeping It Simple
For Beginners
Start with simple options: 1. Target date fund: One fund does everything 2. Three-fund portfolio: Basic but effective 3. Robo-advisor: Algorithm manages for you
As You Learn More
You can get more sophisticated: - Add international developed markets - Include emerging markets - Add real estate (REITs) - Consider individual stocks (small portion)
Advanced Options
For experienced investors: - Factor tilting (value, small-cap) - Alternative investments - Individual stock picking - Tactical asset allocation
Monitoring Your Portfolio
Regular Check-ins
Review periodically: - Quarterly: Check if allocations have drifted - Annually: Rebalance back to targets - Life changes: Adjust for new goals or circumstances - Donāt obsess: Daily checking creates stress
When to Make Changes
Good reasons to adjust: - Major life events (marriage, kids, job change) - Significant goal changes - Risk tolerance changes - Age-related adjustments
Bad reasons to adjust: - Recent market performance - Financial news or predictions - Friendsā investment advice - Fear or greed
The Bottom Line
Good portfolio construction is about: 1. Matching your situation - goals, timeline, risk tolerance 2. Keeping it simple - donāt overcomplicate 3. Staying diversified - spread your risk 4. Being patient - let time work for you
Most important: Start with something simple and improve it over time. Perfect is the enemy of good.