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An investment portfolio is the set of financial assets held by an investor, with the objective of obtaining a return and diversifying risk.
An investment portfolio can be composed of different types of assets, such as stocks, bonds, funds, currencies, commodities, etc.
What is an investment portfolio for?
An investment portfolio serves to:
- Monetize the available capital, by investing it in assets that generate income, such as dividends, interest, capital gains, etc.
- Diversify risk, by combining assets that have different levels of return and volatility, as well as different correlations with each other, which reduces exposure to potential losses.
- Adjust the investment profile, by selecting assets that suit the investor’s preferences, objectives, time horizon and risk tolerance.
How is an investment portfolio constructed?
To build an investment portfolio, the following steps should be followed:
- Define the investment profile, i.e. the set of personal, financial and psychological characteristics that determine the investor’s needs, expectations and attitude towards investment. Some factors that influence the investment profile are age, income level, net worth, objectives, time horizon, risk, etc.
- Analyze the financial market, i.e. the economic, political, social and regulatory environment that affects the behavior and performance of financial assets. Some factors that influence the financial market are growth, inflation, exchange rate, interest rate, supply and demand, etc.
- Select financial assets, i.e. the instruments that make up the investment portfolio, according to their expected return, their associated risk and their correlation with the other assets. Some criteria that can be used to select assets are fundamental analysis, technical analysis, quantitative analysis, etc.
- Assign the weight of each asset, i.e., the proportion of capital invested in each asset, according to its importance and contribution to the investment portfolio. Some methods that can be used to assign the weight of each asset are mean-variance optimization, efficient frontier, Markowitz model, etc.
- Evaluate the performance of the investment portfolio, that is, the result obtained by the investment portfolio, comparing it with the established objective and with the performance of other similar portfolios. Some indicators that can be used to evaluate the performance of the investment portfolio are return, risk, Sharpe ratio, alpha, beta, etc.
- Check y adjust the investment portfolio, i.e., the process of modifying the composition and weight of the assets in the investment portfolio, according to changes in the investment profile, in the financial market or in the performance of the investment portfolio. Some reasons that may motivate the review and adjustment of the investment portfolio are price variation, the appearance of new opportunities, maturity of assets, failure to meet objectives, etc.
What are the risks of an investment portfolio?
An investment portfolio has different types of risks, which can negatively affect its profitability and value. Some of these risks are:
- The market riskwhich is the risk that the value of the assets in the investment portfolio will be affected by fluctuations in the financial market, due to factors such as supply, demand, exchange rate, interest rate, etc.
- The credit riskwhich is the risk that the issuer of an asset in the investment portfolio will not meet its payment obligations, either due to insolvency, default or bankruptcy.
- The liquidity riskwhich is the risk that the investor will not be able to sell or buy the assets of the investment portfolio at the price and time he/she wishes, due to lack of demand, supply or intermediaries in the market.
- The concentration riskwhich is the risk that the investment portfolio is composed of few assets or assets that are very similar to each other, which increases the exposure to possible losses.
- The diversification riskwhich is the risk that the investment portfolio is composed of many assets or assets that are very different from each other, which reduces the potential return.
What tips can be followed to improve an investment portfolio?
Some tips that can be followed to improve an investment portfolio include:
- Define y respect the investment profile, aligning the objectives, term and risk of the investment portfolio with the personal, financial and psychological characteristics of the investor.
- Get informed y keep up to date about the financial market, following trends, news, analyses and recommendations from experts, as well as current regulations and standards.
- Select y diversify financial assets, choosing those that offer a good relationship between profitability and risk, as well as a low correlation between them, which allows taking advantage of opportunities and reducing losses.
- Assign y balance the weight of each asset, distributing capital in a proportional and balanced manner among the different types of assets, according to their importance and contribution to the investment portfolio.
- Evaluate y compare the performance of the investment portfolio, measuring the result obtained by the investment portfolio, contrasting it with the established objective and with the performance of other similar portfolios.
- Check y adjust the investment portfolio, adapting the composition and weight of the assets in the investment portfolio, according to changes in the investment profile, in the financial market or in the performance of the investment portfolio.
