This is the first of a two-part series. In this post we will explore what are the actual steps and mechanics involved in starting an investment portfolio? In the next post, I’ll explore how you should go about building your portfolio.
I’ve been building investment portfolios for clients for 20 odd years now. What I’m going to share with you are the actual steps we use to deliver successful outcomes for our clients.
Step 1 when planning how to start, an investment portfolio has to be determining your objectives. A portfolio created to achieve the objective of buying a home in 2 years will be very different to a portfolio built to enable early retirement in 10 years.
Write down your objectives, and be really clear on what you’re trying to achieve. Don’t have, “I want to save money for a home deposit”. Instead write down something like, “I want to build up a $100,000 home deposit by July thousand and whatever”. Quantify your objective.
If you have a partner, check with them that you’re both on the same page. You’d be amazed how often I get new husband and wife clients in, and their vision for years ahead differ greatly. Sitting down with me seems to be the first time they’ve had a discussion of what their preferred future looks like.
It may be that you have more than one objective. For instance, building a portfolio to enable early retirement, whilst also wanting to pay off your mortgage. To move forward with starting your investment portfolio, you need to determine which of these is more important. There are occasions where you can be working on multiple goals at once, but there are plenty more times where a sequential approach is more appropriate. In this example of wanting to build an investment portfolio to enable early retirement, whilst also wanting to get the home loan paid off, I would normally encourage clients to get the home loan goal achieved first, and then think about the early retirement goal. Now this is not always the right answer, but the points is when you have multiple goals, you need to think through carefully whether you can working on them all at the same time, or whether some need to be put on the back burner.
In starting your investment portfolio, you’re trying to generate a return better than leaving your savings in the bank.
What determines your expected return is the amount of risk that you take.
It’s helpful to think of risk and return, as being on a spectrum. At the extremely low risk end, you have cash in the bank. You’re not going to lose your money (ignoring inflation anyhow), but the return is essentially zero.
The next step up is perhaps a bank term deposit. Your return is perhaps 2%, the risk is you’ve locked your money up for the term, say 6 months. Interest rates could rise, or you could have a need for your money.
The spectrum would continue – bonds, balanced type funds (where they are true 50/50 growth to defensive splits), then growth funds, then a share portfolio, property, and perhaps at the outer end, geared investment.
I had someone in last week who had invested in corporate bonds and had been earning about double the term deposit rate. She’d recently been advised that one of the companies was in difficulty and bond holders would not get back their full investment. She was horrified.
She’d missed the risk/reward linkage. If you’re getting twice the return of a term deposit, then you’re taking on roughly twice the risk. There’s no such thing as free lunch, as the saying goes.
But the risk is not something to be avoided when starting your investment portfolio. Rather, it’s something to be embraced. By putting your money to work, taking on some risk, your money earns more money, so that your objectives can be achieved more quickly than relying on your savings capacity alone.
The level of risk you take when starting an investment portfolio is determined in part by your personal comfort levels, but perhaps more importantly by your investment time frame.
With any luck you’ve addressed your investment portfolio time frame when you established your objectives. Being clear on your time frame is crucial, because it has a large impact on the degree of risk that you can take.
If the objective of your investment portfolio is to be achieved in 2 years, then the risk you can afford to take on is fairly low. Higher risk investments are more volatile from one year to the next, both in terms of the earnings that they generate, and also the value of the amount you initially invested. So higher risk investments need longer time frames. If you look at the fund profiles of most managed funds and ETF’s, they will usually have minimum suggested time frame, which is a really useful guide.
Matching your time frame to your level of risk is crucial when thinking through how to start an investment portfolio. Here’s a very rough guide:
Time frame of 2 years or less – bank deposits
2-4 years – Consider some sort of conservative or balance fund that has less than 50% of its total assets in shares and property.
5-7 years – look for growth fund mix that is majority shares and property. Depending on personal comfort levels, at this time frame you could even go out to 100% growth assets – shares and property.
7 years+ – typically 100% growth assets, and if you have the appetite, quite possibly incorporate some gearing in there too to magnify outcomes.
Opening a share trading account
For those medium to long term objectives, it’s likely that you will want to buy some ETF’s or perhaps even some direct shares. To do that, you need a share trading account.
A good place to start is to see if your bank offers share trading. If so, setting up an account through them is likely to be the most painless, as they will already have all of your identification details. If not, here’s the main providers in Australia that I see:
Take a look at this piece on the Money Smart web site – how to buy and sell shares.
You will link your share trading account to a bank account. Some will make you create a new bank account with them even. Once you have money in the linked bank account, you are ready to start buying, and hopefully well down the track, selling also.
Well that’s it for How to start an Investment Portfolio. This is largely about the steps to take before putting your first dollar to work. As mentioned at the start, our next post will focus on how to build your portfolio.
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Resources & Links
- How to build an Investment Portfolio
- Investment basics – Active vs Passive investment – what’s it about and, our approach
- My 68% return. The power of gearing – how smart borrowing can accelerate your journey to financial autonomy
- How to Buy and Sell Shares
- Gaining Choice Newsletter
- NAB Trade
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