Wealth

Your guide to building an investment portfolio

An investment portfolio helps you to build wealth over time. These are some key steps to ensure success when developing your strategy.

Deciding to build an investment portfolio puts you on the path to creating future wealth. But before you start, you need to set goals and work out your risk appetite, both of which vary from person to person. Understanding these factors is a critical first step.

The other important part of the investment journey? Consistency. A steady approach to investing over time is a sure-fire way to build wealth. Read on to understand the steps to developing an investment portfolio and some common pitfalls to avoid. 

1. Develop investment goals

The first step to starting an investment portfolio is to set specific goals. Allan Grant, Senior Financial Adviser at Australian Unity, recommends setting both lifestyle and financial goals.

“The more certain you are about the amount and timing of your future expenditure, the easier it is to set investment goals,” Allan says. This is because you can work back from that total amount you need and set aside a regular portion of your income to get you to there.

Here’s a simple example of an investment goal. Carly and Sam have a newborn daughter, Amelia. They dream of being able to give her $250,000 when she reaches age 25 to help her with a deposit on a property. If Carly and Sam have $50,000 ready to invest now, we can determine that they would need to achieve a return of 6.65 percent a year (after taxes and fees) to reach the $250,000 goal in 25 years. This assumes they are not going to invest other amounts along the journey.

Your goals might be to fund an early retirement or, like Carly and Sam, help your children when they leave the nest. Whatever your goals, mapping them out and putting in place a plan to reach them – powered by compound interest or capital growth – strengthens your chances of success.

2. Determine your appetite for risk

There is a risk factor to consider when making investments, and you need to understand your personality to determine the level of risk you are prepared to accept. Australian Unity Financial Advice uses a proprietary risk-profiling questionnaire tied to a scoring system to gauge their customers’ risk appetite.

“To help clients assess their risk appetite, we also inform them on historic returns, typical volatility they may experience and the potential for losses over time for different asset classes, including shares, property and fixed interest,” says Allan.

“Once we understand the client’s risk profile, we consider their investment time horizon and establish an appropriate allocation to growth, defensive and alternative assets,” he adds.

If you’re unsure where to start, an experienced financial adviser can help put things in perspective. 

3. Work out the right investment for your risk appetite

Diversifying across asset classes is one of the keys to minimising risk and maximising the returns of an investment portfolio. It’s the old cliché: don’t put all your eggs in the same basket. There are three main types of asset classes:

  1. Growth assets. These asset classes are designed to produce capital growth and income over the long term, with higher risk and volatility than defensive assets. They include Australian shares, international shares, Australian property, international property and infrastructure.
  2. Defensive assets. These asset classes primarily produce income and, in some cases, capital growth over the long term, with lower levels of volatility than growth assets. They include cash, term deposits, and Australian bonds and fixed-interest investments, as well as international bonds and fixed-interest investments. 
  3. Alternative assets. Returns from these assets aren’t generally correlated to growth and defensive assets. They include commodities, hedge funds, private equity and venture capital.

Individuals with a higher risk appetite, for example, will have higher allocations to growth and alternative assets, and less exposure to defensive assets.

4. Build and monitor your investment portfolio

Most investors can be split into three categories, which helps to determine how their money should be invested. These categories are determined by how much time the individual wishes to commit to investing on an ongoing basis and how experienced or skilled they are as an investor.

Also, while regularly reviewing a portfolio is essential, it’s important not to have too much of a short-term focus. While it can be tempting to check your portfolio every day, remember your investment goals are generally long term, so your focus should also be on long-term performance. 

Category 1: Investors with minimal time and low skill
Investors who don’t have a lot of time to focus on investing, or who don’t have substantial investment experience, tend to invest in:

  • Multi-sector diversified funds, where a fund manager invests in a diversified pre-mixed portfolio.
  • Managed accounts, where a fund manager invests in a diversified portfolio of shares or managed funds.

These investors should monitor their portfolios at least annually.

Category 2: Investors with moderate time and intermediate skill
Investors who have some time to put towards their investment portfolio and some experience in this area tend to invest in:

  • Portfolios of individually selected, unlisted managed funds.
  • Portfolios of single-sector exchange traded funds (ETFs).

Category 3: Investors with substantial time and high skill
Investors who have substantial time and experience to put towards their investment portfolio tend to:

  • Invest in portfolios of direct shares.
  • Directly invest in property.
  • Directly invest in fixed-interest investments.

These investors should monitor their portfolios at least monthly or quarterly

Understanding where you sit can help you make sound decisions around investing and you’ll be more likely to be successful at building your investment portfolio. 

5. Measure your portfolio’s performance

There are lots of ways to measure your portfolio’s performance, including the following benchmarks:

  • Australian share portfolio returns can be benchmarked against Australian share market indices, such as the ASX200 accumulation index (dividends reinvested).

  • International share portfolios can be benchmarked against relevant share market indices. For example, a portfolio of American shares can be benchmarked against the S&P500 Total Return index (dividends reinvested).

  • If you have invested in managed funds, fund managers publish their own benchmarks, which may be market indices or a peer group of fund managers in the same asset class/category. Use these to measure how well your managed funds are performing.

A good financial adviser should also be able to help you with the appropriate approach to portfolio construction and help you understand and review the performance of your funds.

6. Finally: avoid common mistakes

Investors often make some common – yet avoidable – mistakes when building a portfolio.

One common mistake is wanting to enter the market just after a market crash as share prices are low. “Finding optimum entry and exit points leaves many investors disappointed and is actually very difficult to do,” says Allan.

Another common pitfall is panic-selling during bouts of market volatility and sitting on the side lines until investments have retraced losses. As the saying suggests, it’s ‘time in’ the market, rather than ‘timing’ the market that investors should be focused on.

“Not sticking to an investment strategy and being too aggressive or not aggressive enough are other common problems. Not being properly diversified can also lead to unnecessary losses or returns well below benchmark,” Allan adds.

Finally, it’s important to consider the tax implications of your investment strategy and the right structure in which to hold the investments.

“It’s really important to talk to a financial adviser about tax and structure because it’s a complex area and getting it wrong can seriously hinder your wealth creation capability” says Allan.

With the right approach, long-term outlook and advice, building an investment portfolio is achievable for anyone interested in growing their wealth. And it all starts with your decision to take action.

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