Friday, July 01, 2011

How to Create the Optimal Portfolio

Source: Tax Credits via Flickr
Successful investing is one of the fastest and most efficient ways of increasing your wealth. Unfortunately, since investing requires risk, it is impossible to predict or guarantee the future performance of any account. Thankfully, however, you can reduce or minimize the likelihood of devastating account losses while also maximizing the potential for positive increases. Building a properly structured investment portfolio is akin to creating an artistic masterpiece.



Establish your investment goals. Before risking any of your hard-earned money, you must establish specific future goals related the particular account in question. Your intentions and plans for the money you will invest directly affect how you create the optimal portfolio.


Determine your time horizon. Time horizon denotes the end of your investment plan and indicates the point at which you will begin withdrawing the money in your account. Longer time horizons allow you to take greater risks; if a particular investment choice fails to perform positively, enough time exists to recover those losses before you actually need the money.


Determine your risk tolerance. Not all investments are suitable for all investors. Your risk tolerance is determined by analyzing your responses to specific questions regarding investment-related scenarios. If answered properly and honestly, a risk tolerance questionnaire (see Resources) will indicate your threshold for market volatility, and your comfort level for certain types of portfolio choices. Because investing often elicits powerful psychological and emotional responses, it's important to create a portfolio containing only those vehicles with worst-case potential downsides that fall within the confines of your investment personality.


Choose your investments. Based on your goals, time horizon and risk tolerance, choose investment types that offer the greatest possibility for positive earnings along with the smallest possibility for a decrease in value. For example, a young, aggressive investor might be completely comfortable owning a portfolio comprising international small-cap stocks. Conversely, an elderly investor with a conservative risk tolerance might only be comfortable with a portfolio comprising fixed-income instruments.


Monitor your performance. Once you have made your investment selections, conduct regular reviews and evaluate the performance of your portfolio. Consider replacing underperforming investments with similar choices, and strengthening your position by increasing holdings of the top performers.


Rebalance your account. Over time, the positive and negative performance of each investment choice results in that particular vehicle comprising a different percentage of your total account than what was originally arranged. To maintain an optimal portfolio tailored to your time horizon and risk tolerance, redistribute the money among your investments to recreate the original asset allocation.

Tips & Warnings

Enlist the assistance of an investment professional. The benefits of having the advice, experience and resources of a registered investment adviser or certified financial planner can far outweigh the cost of those services.

Do not monitor the performance of your account on a daily basis. The value of any investment fluctuates, sometimes significantly, over short periods of time. These fluctuations do not necessarily indicate how that vehicle will perform in the long run.



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