An investment portfolio is a collection of financial investments or ‘asset classes’ such as stocks, commodities, bonds, exchange traded funds (ETFs), cash and its equivalents.
But how do you go about building one? First and foremost, you’ll need to be in the position to do so. Because, while investing in the stock market has the potential to provide greater returns than cash savings, there are absolutely no guarantees and you could lose some, or all, of your money.
If you decide to invest however, building a diverse and well-rounded investment portfolio can help maximise your chances of growth, and also help you ride out any downturns in the market.
Here are some things you might want to consider as you put together an investment portfolio, and how to get started.
What type of investor are you?
Before setting out on your investment journey, it’s worth taking some time to consider what kind of investor you are.
To do this, you can ask yourself the following questions.
What are my financial goals?
Setting goals at the outset can guide you towards the most suitable investments in terms of risk and timeline.
Short to medium goals might include:
- Buying a car
- Saving for a deposit on a home
- Saving for a wedding or once-in-a-lifetime trip
Longer term goals could include:
- Building retirement income
- Saving to support young children through university
What’s my timeframe?
Understanding the time you have available can help to determine the level of risk you’re comfortable with.
For instance, if you still have 20 years or more until retirement, you might be comfortable weathering the ups and downs of the market, and building a portfolio that skews towards higher risk – and higher potential growth – assets such as stocks.
Conversely, if you’re saving to buy a home in only five years or so, it might make sense to build a lower-risk portfolio to minimise the likelihood of short-term losses.
What level of risk am I comfortable with?
Even investors who have similar goals and timelines won’t necessarily feel comfortable with the exact same level of risk.
If you employ a financial advisor to build your portfolio, they’ll ask you a series of questions intended to determine your risk appetite.
For DIY investors, the simplest way to assess your risk tolerance is to ask yourself how you’d feel if the value of your portfolio fell by various amounts.
In a typical bear market, your portfolio may lose around 20% to 25% of its value, while during the financial crisis average losses were closer to 40%.
Financial markets tend to be cyclical and investor portfolios are likely to recover in the long-term (more on this below). But if the idea of losses on this scale gives you pause, you may want to assemble a portfolio that skews towards lower risk investments.
Should I invest a lump sum, or little and often?
Usually, investing a lump sum will net you a larger return – provided you remain invested for the long term.
According to analysis from AJ Bell, if you’d invested £20,000 in a typical global equity fund in 2003, your investment would be worth £118,570 in 2023.
If you’d invested the same amount in monthly instalments over 20 years (£83.33 per month), your portfolio would be worth less than half this value – £51,360.
If you opt for regular investments, it’s worth noting that uninvested capital can earn interest if it’s left in a cash savings account.
Assuming the uninvested cash in the example above earned 4% interest in a savings account, the final value of your £20,000 investment would be £70,295 after 20 years’ regular investing.
That said, interest rates change, and it’s unlikely you’d be able to earn as much as 4% consistently over 20 years.
The timing of a lump sum investment can also influence returns. In the example above, the investment was made at the bottom of a bear market – in other words, the market was down and grew in the intervening 20 years.
But even with less favourable timing, lump sum investments tend to offer higher returns.
Understandably, not every investor will have a lump sum sitting around to invest. And despite lower returns, there are some advantages to investing little and often – particularly if there’s a downturn in the market.
Mr Khalaf from AJ Bell says: “When it comes to the losses you sustain in market downdrafts, it’s the regular savings plan which wins the day, because less of your capital is exposed, and your monthly contributions continue to buy shares at cheaper prices.
“If you don’t have the stomach for big falls in the value of your investments, the more regularly you can save, the better.”
Because less of your money is exposed to the market, your investment journey may be smoother. In the lump sum example above, the biggest sustained fall investment value hit 34% – a loss of £14,076.
By contrast, the largest loss incurred by the drip-fed investment was 24%, or £1,635.
Assembling a portfolio
When building an investment portfolio, diversification tends to be key.
Diversification is the practice of investing in a wide variety of asset types, industries and markets, with the goal of reducing your overall risk.
This means if one market, sector or company loses value, the impact on your overall portfolio is limited.
Balancing types of investment
Including several types of assets in a portfolio can support your efforts to diversify. This way, if one type of asset underperforms, you are more likely to have others to fall back on.
Dividing your money between different types of asset is referred to as ‘asset allocation.’
Generally speaking, a diversified portfolio includes a mixture of stocks and bonds. Some investors also bring other higher risk asset classes – such as commodities, property, fine wine or art – into the mix.
Another option you might want to consider is investment funds, which pool resources from multiple investors to invest in a range of equities, bonds or both.
An investor with a high appetite for risk and 20 years or more might opt for a portfolio comprising as much as 100% shares, diversified across sectors and markets.
On the other hand, someone who’s close to retirement might choose a more defensive portfolio, with low-risk bonds accounting for more than 50% of their holdings.
Sustainability is another factor you might want to consider when building a portfolio. To assess the sustainability of an investment, you can turn to ratings agencies such as Moody’s or Sustainalytics.
Many investment platforms also list ESG (environmental, social and governance) centred funds.
Methods for building a portfolio
DIY investing
DIY investing involves picking out investments for yourself (to a greater or lesser degree), and maintaining your own portfolio.
This is typically the most cost-effective way to invest, and you have total control over asset allocation. On the other hand, DIY investors miss out on expert advice, and researching investments could prove time consuming.
Some DIY investors choose ready-made portfolios, created by experts. These portfolios are tailored to different risk appetites, but can’t offer the same level of personalisation as an independent advisor.
Passively managed funds could be another good option for DIY investors who don’t want to dedicate too much time to research. These ‘tracker’ funds aim to replicate the movement of a specific index, such as the S&P 500 or FTSE 100 by investing in most, or all, of the companies that feature in the index.
Investing platforms including AJ Bell, Hargreaves Lansdown and Interactive Investor also compile lists of recommended funds to help steer DIY investors.
Robo-advisors
Robo-advisors can act as a half-way house between personalised wealth management and DIY investing. These services provide a range of portfolios tailored to your risk tolerance and preferences, while using technology to minimise costs where possible.
Independent financial advisors
Independent financial advisors work with individuals to understand their financial goals, and make recommendations on how to achieve them.
This includes building and maintaining an investment portfolio tailored to you. To do this, they’ll ask questions about your financial circumstances, goals, risk tolerance and more, before talking you through their suggestions.
Karen Barrett, founder and CEO of the financial adviser matching service, Unbiased, said: “Make sure you ask [your potential adviser] about their fees and costs, whether they can advise on products from the entire market, and to list the services they offer.
“Also think about whether you need one-off advice or support on an ongoing basis. If the latter, remember you could be partnering with this individual or firm for the rest of your life, so it’s imperative to choose an adviser that you can build a strong relationship with.”
Maintaining your portfolio
Once you’ve built your portfolio, the next step is maintenance. At least once each year, it’s a good idea to check in on its performance and make changes if necessary.
When checking in on your portfolio, it’s also worth considering:
- Have your personal circumstances changed?
Life events such as having a child, changing jobs, moving home or nearing retirement could impact both the amount you have to invest, and your risk appetite.
- Has your portfolio changed ‘shape’?
The value of your investments can rise and fall over the course of a year. If some holdings rise in value much faster than others, they can end up accounting for a larger proportion of your portfolio’s value than you initially intended.
If this happens, you may choose to rebalance the portfolio by selling off some of the high performing assets to invest in others. If one investment has done particularly well over the last year, it may be worth making sure that your returns are not too heavily reliant on that single asset.
- Are any of your investments performing poorly?
If some of your investments have consistently performed worse than their competitors over a number of years, it may be worth considering whether they still belong in your portfolio.
- Have any new opportunities cropped up?
You might decide to invest in a newly burgeoning sector or reconsider your approach to different types of asset.
For example, the last year has witnessed a significant drop in bond prices, and an increase in yields. Investors who have avoided bonds in the past may reconsider when it comes to balancing their portfolio.
How much does investing cost?
The exact price you’ll pay depends on how and where you invest.
On average, a financial advisor will charge around £150 for an hour’s consultation. They may also charge ongoing fees between 0.25% and 1% of your assets under management.
Many financial advisors also provide a free initial consultation so you can gain an understanding of how they work, their fee structure and whether you feel comfortable working with them.
If you choose a robo-advisor, ready-made portfolio, or pick your own investments à la carte, your costs are likely to be lower.
The exact fees you pay vary by provider, but could include:
- Platform fees – The annual fee some investment platforms, such as AJ Bell or Hargreaves Lansdown, charge an annual fee for holding funds in an investment account. This may be a flat fee, or a percentage of the portfolio value, usually in the range of 0.25% to 0.45%.
- Dealing fees – The amount an investment platform charges you for buying or selling an asset. Some major platforms, including Bestinvest, Hargreaves Lansdown and Fidelity, do not charge dealing fees when you invest in funds.
If you choose to invest in funds, each will also charge their own management fees – typically between 0.1% and 0.85% of your holdings for passively managed funds, or 0.75% and 1% for actively managed funds.
Do I need to pay tax on my portfolio?
Tax treatment depends on one’s individual circumstances and may be subject to future change. The content of this article is provided for information purposes only and is not intended to be, nor does it constitute, any form of tax advice.
Investments are held outside of a tax-free wrapper – such as an Individual Savings Account (ISA), or Self Invested Personal Pension (SIPP) – may be liable for tax on your returns.
If your investments earn dividends of more than £1,000 per year, you’ll be liable for income tax. Dividends above this allowance are taxed at 8.75% for basic rate taxpayers, 33.75% for higher rate taxpayers, and 39.35% for additional rate taxpayers.
From 6 April 2024, the allowance is set to be cut to £500.
If you make a profit of more than £6,000 by selling your investments each year, you’ll need to pay capital gains tax.
Basic rate taxpayers pay capital gains tax of 10% on any earnings above their annual allowance. Higher and additional rate taxpayers pay 20%.
Can I lose money?
While diversifying your portfolio can help weather downturns in the market, your capital is at risk whenever you invest, and there’s always a chance you could get back less than you initially invested or lose all of your money.
For this reason, it’s a good idea to consider building up a ‘rainy day’ fund in cash savings before you start investing. Ideally, you want to save enough cash for three to six months’ living expenses.
This way, you’ll have ready savings to fall back on should your portfolio fall in value.
What happens if things go wrong?
If a sudden downturn reduces the value of your portfolio, it might be tempting to sell up in order to minimise your losses.
However, since markets tend to be cyclical – rising and falling at regular intervals – this isn’t necessarily advisable. For example, average FTSE 100 share prices fell 49% in 2009, in the wake of the financial crisis, but rebounded by 41% the following year.
By investing with a long-term view, investors can usually smooth out their average returns. That said, during a recession, investors may opt to take a more defensive stance when it comes to new investments.
If money is lost due to a chosen investment platform going bust, investors may be able to recoup some or all of their money.
Under the Financial Services Compensation Scheme (FSCS), if an investment platform or ISA provider collapses, investments are protected up to the value of £85,000.
