How to Build a Basic Stock Portfolio

Before you buy securities, it is important for you to go through the basic steps of establishing the asset allocation and building your portfolios. Usually you would look at the type of account you are looking to establish and figure out when you would need the money. You would then need to determine your risk tolerance. The easiest way to do that is to fill out a questionnaire online or pick one up from a financial advisor’s office.
Your risk tolerance will help you determine what type of asset allocation you need. There are five basic allocations that correspond to the level of risk one is willing to take: conservative, moderately conservative, moderate, moderately aggressive, and aggressive. The difference between these allocations is the ratio of fixed investments to equity investments within portfolios. For example, a conservative portfolio may consist of 10% equity investments and 90% fixed investments, while an aggressive portfolio may be the opposite.
Once you’ve established a fixed/equity ratio that you are comfortable with, it’s time to select specific investments for your portfolio. There is a pretty basic process you can follow to achieve a balanced investment allocation. When choosing investments for the equity portion of your portfolio, be sure to choose those that fit within the following categories:
1. Growth and value. This is the basic premise of building the equity side of your portfolio: you need to have some growth stocks that generate profits from increases in the price of the stocks, and some value stocks that generate profit from dividends. Again, based on your allocation, you will choose the proportion of growth investments to value investments. The more aggressive you are, the more growth investments you may have.
2. Company size: large caps, mid caps and small caps. Cap is financial jargon for capitalization. Market capitalization is basically the way of calculating the value of the company. Since small companies have less capitalization and less of a track record than large companies, they are considered to be riskier.
3. Specialization. You may be interested in purchasing stocks or mutual funds that represent certain sectors, such as technology, energy, healthcare and real estate. This is not a necessary step, but it will definitely provide a better opportunity for gains (not without risk). Keep in mind that sector stocks or funds are generally reserved for the more aggressive allocations.
Now that you’ve put together the equity mix within your portfolio, it’s time to work on selecting fixed investments. The science here is pretty simple: you need some short-term bonds, some intermediate term bonds and some long term bonds. When choosing bonds, be sure to pay attention to their ratings: while some of the lower rated bonds can generate the highest yields, the risk may be substantial.
So why do you need to use so many different types of stocks and bonds (or stock and bond funds if you are building a mutual fund portfolio)? You’ve probably heard the answer before: diversification. It’s an old financial services industry cliché: don’t put all eggs in one basket. It makes perfect sense; if one of your securities is going south, the other ones may pick up the slack.