To build a portfolio, you need to have a detailed plan that outlines the types of asset classes and returns necessary to achieve your goals. Once you have developed a strategy, you can allocate your capital across a diversified portfolio and then manage it. Building an investment portfolio has two stages – portfolio construction and portfolio management.

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You need a plan to build a portfolio…

To manage a portfolio, you need to build a portfolio first, and to build it, you need a plan. I know this sounds repetitive, but it’s crucial. “You mean to tell me that I’ve read all the blogs sequentially to get to this place and be told the same thing?”, Yes that is right.

My job is to write the exact same thing between 50 and 100 times a year in such a way that neither my editors nor my readers will ever think I am repeating myself.

Jason Zweig

Investing is not a magic formula. It is a systematic and repetitive process, and you cannot skip any steps. If you do, the markets will force you to start over again from the beginning. Therefore, never invest without a well-thought-out and articulated plan that outlines what you want to achieve and how you plan to do it.

It’s surprising how many investors are investing without a plan or an investment philosophy. To build and manage a portfolio successfully, you need to start from the beginning. From my experience, investors who have done well, whether they are active or passive, had a plan from day one. They knew the answers to questions like their objectives, what they were trying to achieve, and how they would achieve it. They had self-awareness and worked patiently towards their plan.

I have heard many people say that investing in stocks is not for them because they lost money, or they did not do well. However, they didn’t stick around long enough to see the success of their plan play through. Investing is like a “New Year’s resolution” in that people often fail to stick to their goals and plans. Staying the course is half the battle.

The steps required to build a portfolio.

Let’s work through each of the steps required to build a portfolio. Then we can work through how to manage it. We have touched on these questions already in the investment strategy section. However, in line with being a repetitive prick, let’s rehash them.

There are other questions and areas to consider when building a stock portfolio. I think the below covers the most important factors. If you answer and spend the time addressing each one adequately it can help to make the portfolio structuring seamless.

What is in your hand right now?

To begin building an investment portfolio, it’s important to first assess your current financial position. Start by laying out your current situation, including your financials, capital, savings, and the monthly amount you can comfortably spare. Before you think about investing in stocks read, What to do before investing?

Before deploying your money into the markets, it’s important to get your financial house in order. Investing in equities carries risks and requires “patient capital”. Before investing in the market, it’s best to pay off negative debt with high-interest rates and build an emergency fund. Your negative debt is your “opportunity cost”. Why try to make 8% returns when you have debt that you pay 15% on?

On the other hand, if you have a large amount of accumulated savings or have received a windfall, your starting position will be different. Calculate your monthly spare income for investing after your living expenses, savings, and other costs. This will give you a clear representation of what can be allocated to a portfolio.

Once you have the desired monthly amount and any additional capital, you’ll have a good base to start building your portfolio. For example, if you have $100,000 in savings and can comfortably add $1,000 a month towards your investment goal, you have a clear starting position. So your mission becomes “I will deploy $100k over x timeframe across x asset classes and contribute $1k each month towards this plan”.

So, start by assessing your current financial situation. What is currently in your hand?

Define your goals.

It’s important to have clear goals in the investment process. Without a goal, it’s difficult to give direction to your investments. Your goals can range from building up a nest egg for retirement to achieving multiple objectives with specific time horizons. Your goal determines how everything else fits in.

For example, a general goal like “Create Wealth” is great, but it’s essential to have a clear purpose that underpins this goal. This could be to be independent and generate wealth for your family, with the focus on capital appreciation. Over time, the goal may shift to income generation.

Your goal can be anything – buying a house in 10 years or saving up for your children’s education. However, it’s not recommended to invest for luxury items or depreciating assets. This goes against the philosophy of investing long-term and my “Reasons to sell a stock“.

Investing long-term should be consistent with a big-picture view, backed by a strong, compelling goal that gives the journey purpose. Therefore, start thinking about your goals and what you want to invest for.

Determine your risk profile.

Understanding your risk profile is crucial when building a portfolio. If you have read the blog about risk, you would have seen the different types of profiles that exist. To simplify it, there are three main risk profiles: conservative, moderate, and aggressive.

It’s important to think about how you see yourself within these profiles. There is no rule about risk, but consider your personality and how you would feel about losing a large percentage of your portfolio. Would it cause a lot of anxiety or sleepless nights? Or would you be able to bounce back emotionally? Do you have a high-risk appetite and can stomach large drawdowns?

Understanding your tolerance for risk will help you form a portfolio of stocks that can be hedged against your risk profile while still aligning with your goals. If you’re risk-averse, you may invest in safer asset classes. However, this may limit your overall returns, which could prevent you from achieving your goals. Therefore, it’s essential to strike a balance between risk exposure and potential returns that align with your goals.

One of the best ways to understand your risk profile is through a mental exercise. You can identify your risk tolerance by answering a series of questions and picturing each outcome mentally. For instance, if you lost 20% of your portfolio today, how would you react? Would you withdraw your money, curl up into a ball, stay invested but be vexed, or deploy more capital? These scenarios can help shape your risk profile to some extent.

Lay out your time-horizon.

It is important to allocate a time horizon to each of your goals. This gives you a “Time-Bound” commitment that turns goals into a reality. Short-term, medium-term, or long-term horizons can be given to a goal. I classify short term as beyond 3 years because we are investing in equities. Investing in markets for a year or two can be risky, and it requires patient capital to invest in equities. Of course, you can invest in a 1-year maturity bond or fixed-income account, but we are talking about stocks in general.

The time horizon allows you to reverse engineer the returns required per year by taking the Goal Amount (whether it is income or a portfolio value) and finding out the compounding rate over the time frame. This is the easiest way I find when determining how to invest towards a goal.

To simplify this, let’s take an example. A couple has a 10-year goal to buy a house in a nice, quiet country town. The house will cost $1.5 million to buy. They have $500k now and are prepared to allocate $1k out of their current earnings per month towards this goal. They would need to deploy their capital and earn a Compound Annual Growth Rate (CAGR) of 10% annually to achieve the goal. This would mean being highly exposed to all stocks.

The closer you get to the long-term goal, the more risk-adjusted it should become. If someone is nearing retirement and they are still highly exposed to public markets, this becomes risky as it can wipe out a large portion of their portfolio, ruining their retirement goals.

What returns do you need to achieve the goal?

Understanding the required returns is crucial to achieving your investment goals. Sometimes, investors are prone to taking on more risk than necessary, especially when their long-term objectives do not require additional risk-to-reward payoffs.

For example, an investor may need an 8% compounded annual return over 20 years to achieve their goal safely. However, they may be investing in high-risk asset classes that aim for 12-15% returns, which is unnecessary. Conversely, some investors may require only 8-10% returns annually to achieve their objective but are too conservative in their approach and invest only in asset classes returning 4%.

The exact amount needed to achieve your goals is an approximated exercise. For instance, if the goal is to have a retirement fund that pays $5,000 per month income in 30 years, that is equivalent to $60,000 a year in dividends or interest payments from bonds. This can be reverse-engineered by averaging out a yield, let’s say 4%, to determine how much capital is required. In this case, an investment fund of $1.5m in income-producing assets is needed to produce a $60k a year income on a 4% average yield. This is a highly simplified example, but it forms the basis for all investment goals.

Reverse engineering the numbers is a useful strategy. Come up with a number you are aiming for, be it income per month or total portfolio value, and work your way back to estimate the required annual returns.

Here’s another straightforward example. Suppose a 25-year-old wants a $5m portfolio by retirement at 65 years old and plans to allocate $1,000 per month to this fund. They can reverse-engineer the required CAGR (Compound Annual Growth Rate), which would roughly be 9.2% for 40 years.

Determine an investment philosophy.

Developing an investment philosophy is important in shaping the investment outcome. It helps to narrow down your focus and align with a particular investment style, such as passive investing over active investing, or value investing over growth investing. It could also mean aligning with diversification over concentration, or believing in the inefficiencies of markets and exploiting them instead of thinking markets are efficient and not worth trying to beat.

However, it is not necessary to have a hard and fast viewpoint early on. Investors need to explore their options, understand each one and look at all points of view before gravitating towards and fully committing to an investment style.

Having a belief structure can significantly help when building a portfolio. The difference between, say, an active and passive approach varies greatly from how you select stocks, the investment process, the valuation process, and more. By forming a belief around markets and investment styles, you can fine-tune your entire investment journey.

It’s important to realize that your investment philosophy may change and evolve over time, but starting out with a view makes the starting place a little simpler. Many investors are so hard and fast in their beliefs and views, not realizing that they were beginners at one stage. If you’re honest, the starting days were not easy. When you first started investing, you probably didn’t have a formed view of markets, philosophies, or investment styles. They were shaped by experiences, losses, gains, and the expansion of your knowledge around investing. Don’t think you need to know everything 100% before starting. Otherwise, you may never start.

Decide on the target asset allocation in line with goals.

The asset allocation you choose should be based on the returns required to meet your goals. Although your risk appetite is important, your focus should be on achieving the required returns. This is the key to an unemotional and systematic approach to investing. For instance, if your long-term goal requires a 9% Compound Annual Growth Rate (CAGR) but you only want to invest in safe low-risk bonds that yield 3%, then you are failing to understand the concept of investing.

The purpose of asset allocation and diversification is to strike a balance between your temperament, risk tolerance, and your goals. If your goal demands exposure to equities, you have to give it the best chance of being achieved. You can’t compound low returns to reach a goal that requires a higher rate of return.

For example, if your goal is a 9% CAGR, you may decide to have 70% exposure to equities and the remaining 30% in lower-risk asset classes such as bonds or cash. This way, you are balancing risk while giving your investments a good chance to achieve your long-term goals.

There is no one-size-fits-all rule because returns vary across different markets, and asset classes rotate in and out of favour. Sometimes equities are the right choice, and sometimes bonds or cash are the right choice. This is why diversification is wise for most investors. Each portfolio is tailored to an individual investor. However, I believe that returns should determine the optimal mix of asset classes. If your goal demands returns of 8-12% CAGR, then you need to have a higher exposure to equities. If you need only 3-5% returns annually, then you can have a higher allocation to safer asset classes.

Target Asset Allocation is determined by the required rate of return your goal demands.

Deploy capital inline with the strategy.

It is surprising how many investors have a plan, set goals, establish a philosophy, and arrange everything. However, over time, they end up in positions that do not align with their objectives. It is crucial to invest in line with the plan. All asset classes and positions must correlate with the goals and strategy.

Do not get distracted and avoid deviating from what you have already set out. It can be challenging to be disciplined when managing your own money. That is why it is advisable for most people who want to invest but lack interest, curiosity, or time to seek professional management or advice. This is because the advisor will usually adhere to the plan.

Deploy capital in line with your plan and make adjustments and rebalance when the strategy is out of balance or your circumstances have changed. Until the target is achieved, do not stray. This is probably half the reason I have done well in investing (the other half being luck). I laid out a plan, and I did not deviate. I was always good at saying, “I am going to do this by this time, do or die.”

Once you have decided on a portfolio strategy, build a portfolio that is a representation of the strategy. Yes, market conditions will change, and economic cycles will occur. You adapt as new information arises, not because you are eager to tinker with the portfolio.

Monitor the portfolio and rebalance when needed.

Continuous monitoring and rebalancing are crucial to successful portfolio management. There is no hands-off approach when it comes to investing. Even a buy-and-hold strategy requires periodic checking to ensure everything is on track. For example, during a market downturn, you may want to reposition yourself defensively or take advantage of lower costs.

You don’t need to be alert all the time, but it’s important to stay in tune with the world around you and your investments. Rebalance your portfolio when your target asset allocation is out of balance, and never sell without a good reason. Another powerful outcome of compounding is deferring taxes until you sell. Every time you buy or sell, there may be tax implications and transaction costs. Compounding capital tax-free over long periods of time is a smart strategy.

If you’re an active investor, monitor your positions and see if there is a break occurring. Keep your finger on the pulse of the market by monitoring company movements and announcements.

Whenever a bond or fixed account matures, shop around for the best return. Building a portfolio requires constant management. I don’t recommend checking once a year or every morning out of anxiety. Instead, a monthly check-in to monitor and rebalance is important because it gives you a sense of purpose. You start to feel like you’re working towards something. Take an interest in your future.

An advisor usually provides a monthly or quarterly report, so managing your portfolio in line with this is effective. You should always know exactly your portfolio’s positioning and keep a list of things to watch out for.

For me personally, I’m always watching, looking at new opportunities, weighing up what I have, analysing the movements in the world, and keeping an eye on parts of my portfolio that may require some change.

Stay the course – until goal achieved.

The most challenging aspect of investing is to witness the growth of your investments. People often talk about the fear of failure and losing money more than the challenges that come with success. However, when your investment plan begins to bear fruit, that’s when it becomes more challenging. After years of investing, it may be tempting to stop regular contributions or withdraw funds for other purposes.

Many investors have put in a lot of hard work, set up their investment plan, and consistently allocated funds to it over the years. Sometimes, they may feel tired and want to try something new. However, discipline and focus on their goals are essential at this stage. It may sound strange, but even young (in my eyes) investors like myself have experienced this as I started quite early on. It’s crucial to take a step back, reflect on the goals, and stay the course.

Consider this scenario: If you started investing at the age of 30 and are now 48, with a well-compounded portfolio, you still have 12-15 years before retirement. The temptation to deviate from your plan is high, but it’s imperative to deviate only if it’s in pursuit of another worthwhile goal.

Understand each Asset Class and how they correlate.

Investors often focus on selecting individual securities or funds for their investment portfolio and deciding on their target asset allocation. However, they may spend less time studying how different asset classes are correlated to one another. The idea of diversification is not just about spreading across asset classes, but also about hedging asset classes against each other to avoid over-weighting uncorrelated positions.

Each asset class and segment within it operates independently. For example, during bull markets, large-cap and small-cap equities perform well, but in bear markets, investors tend to prefer large-cap and stable companies over smaller companies. When interest rates are high, investors often flock to higher yielding bonds and fixed income. In recessionary times and bear market fears, defensive positions are built up in gold and other commodities that can protect wealth.

Investors need to understand why and how asset classes move in and out of favour and how to diversify their target asset allocation accordingly. Diversification in portfolio management means ensuring that when one asset class is down, another can bring stability and hedge against the risk of over-exposure.

One common mistake is over-diversification and portfolio overlap. Investors sometimes believe that diversifying far and wide will build a fool-proof portfolio, but many funds, index funds, and individual securities may overlap. It’s important to look deep within each fund or security to ensure it actually brings the safety of diversification through uncorrelated risk mitigation.

Build a portfolio over time…

When constructing a portfolio, it is recommended to do it over time. If you find yourself with a lump sum to invest, it is better to deploy it gradually across your target asset allocation. While shopping around, it is essential to make sure you understand each of the products or companies you are investing in. If you are looking to build out the bond component or fixed income portion, shop for the best rates. If you are comparing index funds, look for not only low-cost management fees but also the ones that are best aligned with your strategy. Ensure there is liquidity in the investments you are considering.

Determine the amount allocated to each asset class and also the frequency which can help to address timing issues.

Building a portfolio takes time, even if you are dollar-cost averaging. You cannot decide to invest and then after a few weeks, have a portfolio. It rarely goes like that. You piece together the portfolio over time. The more the portfolio builds, the more confidence and knowledge you accumulate.

This is how my journey from buying my first stock at 19 years old to now has evolved. Every loss, mistake, and gain I learned from. I learned about market timing, asset allocation, returns, risk, complicated products, and the cycle of asset classes. The more my portfolio developed, the more I understood how each portion worked in correlation to another.

You learn a lot from taking action. That is why it is essential to build a portfolio over time. Don’t rush it. From day one, take it seriously. Don’t think it’s a game. Take your financial life seriously, and the results will follow.

Portfolio Management changes the wealthier you get.

I would like to emphasize that investment portfolios change as you become wealthier. While the fundamentals such as asset allocation may not change, the goals largely determine the outcome. As a beginner investor, you are building a portfolio in line with variables like career income, debt, household expenses, and other costs.

Your goals may be entirely different as you are investing to achieve specific goals and accumulate wealth or income. On the other hand, wealthy individuals invest to achieve a return, but their goals are very different. They may invest with the sole goal of creating generational wealth, preserving wealth for the future, and maximizing the returns of the portfolio.

The risks can be vastly different for an individual investor midway on their journey. High net worth individuals (HNWI) can withstand larger drawdowns as they have other assets they can fall back on. They can take on more risk, adapt to changing markets, and go all-in cash without needing to earn high returns. They also may have access to a range of financial products not accessible to the public.

Some readers may already be wealthy and looking to continue to compound their capital. In such a case, setting out goals and time horizons is pointless, and risk tolerance may not be required. The goal is to “Compound and preserve capital.” So, you are positioning yourself offensively to maximize returns or defensively to protect returns. In this case, the goal may be to achieve an overall rate of return of 10% annually on the portfolio. Every investment, portfolio construction and portfolio management decision will gravitate around this goal.

What exactly does Portfolio Management involve?

It’s a great question: once you’ve started constructing a portfolio, how exactly do you manage it? Managing a portfolio is not complicated if you follow a systematic and disciplined approach.

For me, the outcome of sound portfolio management is achieving the goal. This means the sole purpose of managing a portfolio is to ensure the pieces you’ve carefully constructed continue to be in line with your goal. Below, I’ve outlined my key criteria for ongoing portfolio management:

1. Keep up with market movements: While I don’t believe in being glued to financial media, I still keep my thumb on the pulse. Look at market trends and changes in the economy to prepare for a defensive or more aggressive position.
2. Track record and performance: You need to know how you’re performing, not quarterly or weekly but annually. What was the rate of return for the year? What were the errors? Measuring your track record helps ensure that it’s in line with your goals.
3. Ensure target asset allocation is on point: Always check if the target weightings are on track. If you’ve allocated according to a sound strategy, don’t deviate from it.
4. Automate what should be automated: If you’re dollar-cost averaging, automate it. If you don’t have a schedule of rebalancing, automate it. Systematically automate what you can to remove human emotions. Reinvest dividends if you don’t need them.
5. Adjust HRHR (High-Risk High Return) with LRLR (Low-Risk Low Return): as your goals are either met or you go through different life stages, such as from wealth accumulation to wealth preservation and income generation.
6. Monitor underlying companies: Always keep an eye on your holdings and look for signs of thesis break, sell signals, or chances to top up.

In Summary…

This summarises how I think about portfolio construction and portfolio management. Whilst it may not have broken down asset class selection and gone through examples of portfolios it gives an idea of how to build a portfolio and some pointers to manage it.

This blog is for investors who want to manage their own money. It is hard to create a cookie-cutter solution that suits everyone. There is a lot of “how to build a portfolio or what is the best way to manage a portfolio?” but you need to rethink this and remember, Why you are building a portfolio.

Portfolio Management is the practice of piecing together and overseeing a group of assets that deliver the investor’s strategy to achieve long-term financial objectives in line with their risk tolerance.

For investors like me who take an interest in maximising their returns a hands-on approach is the best way to do that. I don’t see any other way. Managing a portfolio is part art and part science.

This is why I think set-and-forget rarely is a good strategy for most active investors who want to manage their wealth. Now, I’m not suggesting being glued to a screen, we all have better things to do than to watch tickers fluctuate, but setting aside dedicated portfolio management time is important.

I don’t believe it’s hard to build a portfolio or manage it. It’s not easy, but it’s not as complex as it’s often made out to be. Where it becomes hard is where there is no sound strategy. That’s why if investors are not prepared to sit down, write out goals, think about risk, and time horizon and understand the basics of all the key terminologies, active/passive, value/growth, small-caps/large-caps, bonds/cash, then I believe it becomes hard and not worth the risk-to-reward payoff.