4 Steps to Building a Profitable Investment Portfolio in 2025
Building a sound investment portfolio is crucial to any investor’s success in today’s financial market. As an individual investor, you must learn how to allocate your assets in a way that aligns with your investment goals and risk tolerance. In other words, your portfolio should generate the highest possible return with the lowest risk, without causing you any anxiety.
In general, the goal of building a successful investment portfolio is to maximize wealth by increasing returns, while minimizing the risks that the investor may face. However, the question that arises is how to determine the optimal composition or combination of portfolio assets according to return and risk criteria?
4 steps to a successful investment portfolio
Investors can build portfolios compatible with specific investment strategies by following systematic approaches. Below, we’ll provide four steps to help you systematically build a profitable portfolio in 2023:
1. Determine the asset allocation method that is appropriate for your situation.
Assessing your financial situation and goals is the first step in building an investment portfolio. Important factors to consider include your age, the amount of time you have to grow your investments, the amount of capital you will invest, and your future income needs. A single college graduate starting out in their career requires a different investment strategy than a 55-year-old who wants to pay for their children’s college education and have a reliable savings for retirement in just 10 years.
The second factor to consider is your personality and risk tolerance. Are you willing to risk losing money for the potential of higher returns? Everyone wants high returns year after year, but if you’re constantly worried about your investments declining in value over a short period, the high returns you’re looking for won’t be worth the stress and pressure.
Clearly defining your current situation, future capital needs, and risk tolerance will determine how you should allocate your investments across different asset classes. The potential for greater returns comes at the cost of greater risk (a principle known as the risk/return trade-off). The goal isn’t to avoid risk entirely, but rather to leverage it to suit your circumstances and investment style. For example, a young person who doesn’t rely on their investments for a steady income can take greater risks in their pursuit of higher returns. On the other hand, someone approaching retirement should focus on protecting their assets, generating income from these assets, and following investment plans with tax advantages that ensure the lowest possible taxes.
Conservative investors vs. impulsive investors:
The more risk you can tolerate, the more aggressive your portfolio will be—a larger portion of your investments will be allocated to stocks and a smaller portion to bonds and other fixed-income securities. Conversely, the less risk you can tolerate, the more conservative your portfolio will be. Here are two examples: one for a conservative investor and one for a moderately aggressive investor.
Conservative wallet
- 70-75% fixed income securities.
- 5-15% cash or equivalent
- 15-20% shares.
The primary goal of a conservative portfolio is to protect its value, and the allocation pattern described above will produce steady income from bonds and provide some long-term capital growth potential from investing in high-quality stocks.
relatively aggressive portfolio
- 50-55% shares
- 5-10% cash or equivalent
- 35-40% fixed income securities
The relatively aggressive portfolio is suitable for those with an average risk tolerance and is attractive to those who are able to tolerate more risk in their portfolios in order to achieve a balance between income and capital growth.
2. The stage of creating an investment portfolio
Once you’ve determined the appropriate asset allocation method, you’ll need to allocate your capital among the appropriate asset classes. At the initial level, allocation isn’t difficult: stocks are stocks, and bonds are bonds.
You will need to divide the underlying asset classes into subclasses with specific risk and return ratios. For example, an investor might diversify the equity asset class by creating a mix of emerging companies and markets to balance small companies with high growth potential with larger, more established businesses, and between domestic and foreign stocks. The bond asset class might be divided between short-term and long-term bonds, government debt and corporate debt, and so on.
There are several methods you can use to select assets and securities that will fit your asset allocation strategy (you will need to analyze the quality and potential of each investment you purchase, as bonds and stocks are not created equal).
* Stock Selection – Choose stocks that meet your risk tolerance in the equity portion of your portfolio. The stock sector, market capitalization, and stock type are key factors to consider. First, create a comprehensive list of potential companies and then filter them using stock screeners (software that helps filter stocks according to a wide range of criteria) to obtain a shortlist. Second, conduct an in-depth analysis of each potential stock to determine its future opportunities and risks. This is the most labor-intensive stage of adding securities to your portfolio, requiring you to regularly monitor changes in your investment prices and follow the latest news on your stock companies in particular and sectors in general (for more information, read “4 Steps to Stock Selection”).
* Choosing a bond – There are several factors you should consider when choosing a bond, including the coupon value, maturity date, bond type and rating, as well as the general interest rate environment.
* Mutual Funds – Mutual funds are available in a wide range of asset classes and allow you to purchase stocks and bonds that have been professionally researched by fund managers before selecting them. Fund managers will, of course, charge fees for their services, which will reduce your returns. Index funds are another option, and their fees are lower because they reflect an existing index and are therefore passively managed.
* Exchange-traded funds (ETFs) – These are a good alternative if you don’t want to invest in mutual funds. ETFs are essentially mutual funds that trade like stocks. They are similar to mutual funds in that they represent a large basket of stocks – grouped by sector, market capitalization, country, or similar. However, they differ in that they are not actively managed, but rather track a specific index or other basket of stocks. Because they are passively managed, ETFs offer cost savings compared to mutual funds, while also providing diversification. ETFs cover a wide range of asset classes and are useful in complementing and diversifying your portfolio.
3. Re-evaluate the portfolio.
Once your portfolio is formed, it should be rebalanced periodically, as market movements can cause changes in the initial values of your investments. To assess the actual asset allocation in your portfolio, categorize the investments quantitatively to determine their value relative to the total investments.
Other factors that are likely to change over time include your current financial situation, your future needs, and your risk tolerance. If these factors change, you will need to adjust your portfolio accordingly. For example, if your risk tolerance decreases, you may need to reduce the amount of stocks in your portfolio. Or you may become more willing to take on risk, and therefore allocate a small percentage of your assets to high-risk small-cap stocks.
If you want to rebalance, determine which asset category has over- or under-allocated. For example, let’s say you have 30% of your current assets invested in small-cap or emerging-market stocks (higher risk), when you’re only supposed to allocate 15% of your assets to this category. Rebalancing determines how much you need to reduce in this category to allocate to other categories.
4. Rebalance the portfolio strategically.
Try to maintain the asset allocation you’ve chosen in your investment strategy until you feel it’s time to change it, based on your aging or changing financial situation. To maintain your current asset allocation strategy, you’ll need to rebalance or completely reallocate your portfolio from time to time.
When you decide it’s time to rebalance your portfolio, there are several ways to do so:
* You can sell a portion of an investment asset that has increased in value significantly, and reinvest its profits in another asset that has not yet increased.
* You can change how new investment funds added to the portfolio are allocated, by placing them in other types of assets whose prices are still below their fair value, until the investor reaches the allocation that suits him.
* You can increase the capital of the investment portfolio, and allocate the increase to invest entirely in assets that are still below their fair values.
Use the method we discussed in Step 2 to select securities when creating an investment portfolio for the first time.
*Note that when you sell assets to rebalance your portfolio, there are tax implications, which will reduce your returns. At the same time, you should consider the future of your investments. If you anticipate that over-growth securities are close to collapse, selling them becomes necessary despite the tax implications. Analyst opinions and research reports are useful tools to help gauge the future of your investments.
* Remember the importance of diversification.
It’s crucial to remember the importance of diversification and maintain it throughout the entire investment portfolio building process. It’s not enough to simply own securities in every asset class; you must diversify within each class as well. Ensure your investments in a given asset class are spread across a variety of subclasses and sectors.
As previously mentioned, investors can achieve excellent diversification using mutual funds and ETFs. These investment vehicles allow individual investors to benefit from economies of scale enjoyed by large mutual fund managers, which the average person would not be able to achieve with a small amount of capital.
Conclusion
In general, a well- diversified investment portfolio is your best chance of maximizing long-term investment growth. It protects your assets from the risks of large downward movements and structural changes in the economy over time. Monitor your investments closely, make adjustments when necessary, and you’ll have a greater chance of achieving significant financial success over the long term.
Read also: The optimal investment portfolio for rewarding returns.
