How to Build an Investment Portfolio

Portfolio investment defined

A portfolio investment is one you make with the expectation the holding will either gain value or generate interest or dividend income. A portfolio investment differs from an investment in a business you directly operate in that your stake is passive, meaning you don't make management decisions. Your investment portfolio can include:

• Stocks
• Bonds
• Mutual funds
• Exchange-traded funds (ETFs)
• Real estate investments, like real estate investment trusts (REITs)
• Cash equivalents, such as certificates of deposit (CDs) or savings accounts

Understanding risk tolerance and asset allocation

The first step is to decide the level of risk you're comfortable with. Higher-risk investments can generate high rewards, but they also can result in large losses. Generally, investing in stocks produces the highest returns, while investing in bonds increases the stability of your portfolio's value.

Younger people saving for retirement can invest primarily in stocks to maximize the growth of their portfolio's value because they have more time to recover if it incurs any large losses. Later in life, those same investors can concentrate their portfolios more heavily in bonds as they approach retirement and their risk tolerance decreases.

Some investors choose to further diversify their portfolios through asset allocation. Basically, this means having more than one asset class in your investment portfolio's holdings. This could include equities like stocks and funds, fixed-income investments like bonds, and cash or CDs.

This kind of portfolio diversification is key to managing the risks of individual investments. Mutual funds and exchange-traded funds (ETFs), which provide automatic exposure to hundreds or even thousands of companies, are great options to help any beginner investor diversify their holdings.

Having a mix of types of investment accounts is also a good idea. Investing in a tax-advantaged retirement account, such as a 401(k) or an individual retirement account (IRA), is a smart choice for any investor who's eligible. You may also want to establish a taxable brokerage account, which enables you to access your money at any time without paying an early withdrawal penalty.

Diversifying the investments in your portfolio in a way that diversifies your tax exposure is also a smart strategy. Traditional 401(k)s and IRAs can accept pre-tax dollars as contributions, with taxation occurring on withdrawals in retirement. Roth 401(k)s and Roth IRAs accept after-tax dollars, which enables tax-free withdrawals in retirement. Maintaining a combination of traditional and Roth accounts can help you save on taxes both now and in retirement.

How to start your investment portfolio

Building a winning investment portfolio is easier than you think. Here's how to get started if you're just learning how to invest. 

1. Look around you

One piece of advice for beginning investors is to buy stock in companies you already know and like.

Are you into fitness? You might want to research Nike (NYSE:NKE) or lululemon Athletica (NASDAQ:LULU).

Do you often eat at Texas Roadhouse (NASDAQ:TXRH) or McDonald's (NYSE:MCD)? Shares of these companies might be good picks for you.

Were you impressed with the theme park operations when you visited Disney World? Or have you seen every Pixar movie ever made? Then check out The Walt Disney Company (NYSE:DIS) stock.

You should consider investing in businesses that play a role in your own life because those are companies you already know something about. You can invest more confidently in familiar brands than in companies you've read about but don't really understand. Investing in small-cap and mid-cap companies that you're familiar with but that aren't widely known is a way to get in on great companies while they're still growth stocks.

Think about what innovative products or services are meeting your needs, or those of your family or community, and offer great customer service. Those companies could be the next Netflix (NASDAQ:NFLX) or Airbnb (NASDAQ:ABNB).

2. Do your research

It's not enough to know or even like a company; you need to have some confidence that the value of the company is increasing over time. To find out what you need to know, look at the company's financial statements.

While all publicly traded companies post their financial performance results online, what's published by the companies may be confusing for many investors. But you don't need to be a financial professional to read through a few quarterly and annual reports to ascertain whether a company is increasing its revenue, profit, and cash flow. Reading these reports can give you both a qualitative and quantitative sense of how well a company is performing.

Portfolio investment example

While there's no single approach to investing that's right for everyone, building a high-performing investment portfolio always involves:

• Clearly defining your financial goals
• Understanding your risk tolerance
• Conducting the necessary research

Let's assume one of your major investment goals is diversifying your portfolio. You decide to invest in an S&P 500 index fund, which provides instant exposure to 500 of the largest publicly traded companies in the U.S. To diversify your holdings and include companies with varying growth potential, you can also buy small-cap and mid-cap stocks. To diversify your geographic exposure, you can contribute money to an index fund that tracks non-U.S. stock markets.

Your choices for how to diversify are nearly endless. You can buy bonds, ETFs, and mutual funds. You can invest money in a 401(k) plan sponsored by your employer in addition to independently establishing an IRA. You can receive income by investing in dividend-paying stocks.

If you want to buy the stocks of specific companies, then inevitably you need to choose among competing options. Let's say you want to invest in either Walmart (NYSE:WMT) or Target (NYSE:TGT). Below are their annual financial results, based on data contained in their most recent 10-K reports for the fiscal year ending Jan. 31, 2024: