There are a few securities in the stock market from which an investor can choose. There are equity shares, debentures, T-bills, derivatives, etc. Now, a person can either invest in them individually or make a bundle of securities and invest in them collectively.
This bundle of securities is known as a portfolio. Depending on your requirements, you can have any security on your portfolio. They can have an all-equity portfolio, which contains only equity shares. You can have an all-debt portfolio – meaning your portfolio will contain only debt instruments. Get the point!
Now, what we will discuss here is how one goes about building a portfolio, its characteristics, and the pros and cons of building a bundle of securities?
Concept Of portfolio
Firstly, let me introduce you to the concept of the portfolio. The main aim of any portfolio is to increase the overall returns for any investor. Think about it, more securities = more chances of better returns. But more securities also increase the overall risk associated with the securities.
Imagine three friends – One was wise, one was smart, and one was dumb. They all had 5 eggs, 3 pieces of bacon, and 2 coins. The wise one kept all his assets in different spots—this way the overall risk is reduced drastically.
The smart friend kept all the eggs together, all the pieces of bacon together, and both the coins together. This way, at least 2 of his assets were safe at any given time. The dumb friend, however, kept all his belongings together. One day a thief decided to make the state of these friends “bearish.”
He first went to the wise one’s home and could steal only 1 piece of bacon. He then went to a smart friend’s home and was able to steal 2 coins. Finally, he went to our dumb friend’s home and ripped him of everything – 5 eggs, 3 pieces of bacon, and 2 coins.
Just like that, to reduce the overall impact of risk on your portfolio, you need to keep your assets in different spots; that is, you have to diversify your portfolio. What does diversification do? It increases your return probability and decreases your potential risk. So, if you have diversified – the risk will be limited, whereas the returns will be the same.
By now, you all must have gotten a rough sense of how portfolios work. You select a few securities (that fulfill your requirements), put ’em’ in a bundle together, and invest in them proportionately.
So, instead of you putting your money into individual stocks, you place it together on a collection of securities. You need not make your portfolio – you get asset and portfolio managers who provide this service. You tell your needs and requirements to them, and they make a personalized portfolio for you.
To be honest, you won’t require managers once you complete a stock market trading course from The Thought Tree. You will be independent and will be handling other people’s wealth, and it is completely liberating, and you get a feeling of independence.
Next up, what are the features of an ideal portfolio? What are the characteristics of a good portfolio?
Characteristics of a Good Portfolio
1. Risk Aversion
The tendency to stick to the known risk and normal returns rather than going for high returns and unknown risk. For example – you are given a choice between choosing $50 and a coin toss, in which if you get tails – you will win $100. If you are a risk-averse person, you will choose $50.
2. Risk Efficient
The portfolio should be as risk efficient as possible. Risk efficiency is the minimum risk one needs to undertake for the expected performance of a particular security.
The portfolio should meet your requirements most efficiently – low cost with optimum utilization.
The portfolio should not demand any more taxes from the investor than need be. The minimum amount of taxes paid to the government is a sign of a good portfolio.
5. Easy Management
The portfolio should consist of securities that can be managed easily, the structure of the portfolio should be easily manageable. The stock market is highly unpredictable, and thus the need to change your portfolio from time to time emerges. Thus, make sure that the portfolio is well built and easy to adjust for your convenience.
These were a few features of the ideal portfolio.
Coming to the types of portfolios. Authority does not officially classify portfolios. These are based on some criteria, which are rather informal and based on risk-return criteria.
Types of Portfolios
1. Aggressive Portfolio
High risk with high return. Aggressive investors generally target companies in their initial stages – with high growth potential.
2. Defensive Portfolio
Low risk with normal return. These portfolios contain household names – blue-chip funds. Securities that won’t be affected majorly by market movements. These are safer and more secure to invest in.
3. Income Portfolio
Portfolio consisting of high dividend-yielding stocks. Again, these generally contain blue-chip funds. These are purely for a steady income source.
4. Hybrid Portfolio
This is a mixture of all types. An all-rounder portfolio. You can grow your wealth and accumulate it in this portfolio. This type usually requires a lot of capital since the number of securities is high.
This is it for now. Stay tuned for more knowledge on portfolios and the stock market.