How to Start and Build an Investment Portfolio From Scratch

Starting an investment portfolio can seem daunting, especially if you’re new to investing. However, with some planning and research, anyone can create a diversified portfolio tailored to their goals and risk tolerance. In this comprehensive guide, we’ll walk you through the key steps for building a portfolio from the ground up.

Step 1: Establish Your Investment Profile

The first step is figuring out your investment objectives. Important factors to consider include:

• Time horizon – How soon will you need to withdraw the money? Can you invest for decades or do you need it in a few years? Longer time horizons allow more aggressive investing,

• Risk tolerance – How much volatility in returns can you stomach? Conservative investors prefer steadier returns with less risk. Aggressive investors seek higher returns despite more risk.

• Goals – Are you saving for retirement, college, a house, or some other goal? Each goal may warrant a different investment approach.

• Income and assets – How much investable income and assets do you have? This impacts how much you can contribute and the investments you can access.

Really think through your unique situation to establish an investment profile before deciding on assets.

Step 2: Allocate Your Assets

Once you know your investment profile, you can allocate assets across major categories like stocks, bonds, and cash equivalents.

Here are some guidelines for determining an asset allocation:

• More aggressive investors allocate more heavily toward stocks for their growth potential despite higher risk. Conservative investors favor more bonds and cash for greater income stability.

• As a rule of thumb, allocate 110 minus your age as a percentage to stocks. So at age 30, around 80% in stocks. At 60, around 50%. Adjust for your risk tolerance.

• Rebalance your allocation as you age to reduce risk exposure. Gradually shift from stocks to bonds over time.

• Diversify across asset classes not heavily correlated with each other to reduce portfolio volatility. Mixing bonds with stocks helps offset equity risk.

Aim for an allocation you feel comfortable with rather than chasing maximum returns. You want to be able to stay invested when markets get choppy.

Step 3: Decide How to Diversify

Diversification involves spreading your investments across different assets that don’t move in perfect lockstep. This lowers your portfolio’s volatility compared to being heavily concentrated in one asset.

When diversifying a portfolio, aim to diversify across:

• Asset classes – Bonds, stocks, real estate, commodities, cash equivalents

• Sectors – Technology, healthcare, utilities, financials, industrials, etc.

• Market caps – Large-cap, mid-cap, small-cap stocks

• Geographies – U.S., international developed markets, emerging markets

• Investment styles – Growth, value, dividends, momentum

You don’t need to diversify across all these dimensions, but mixing it up avoids overexposure to one economic factor.

Step 4: Select Investments

Once you decide on an asset allocation and diversification strategy, it’s time to select specific investments.

For beginning investors, low-cost index funds and ETFs provide instant diversification and are easy to manage. Some popular options:

• U.S. stocks – S&P 500 index fund, total U.S. stock market fund

• International stocks – Total international stock index fund

• Bonds – U.S. aggregate bond index fund, total bond market fund

• Real estate – REIT index fund

Alternatively, target date funds offer an all-in-one diversified portfolio that adjusts over time. Just pick the target date closest to when you plan to use the money.

If going the stock-picking route, thoroughly research companies before investing. Focus on competitive advantages, financial strength, valuation, and growth outlook.

Step 5: Consider Taxes

Taxes can drag down portfolio returns. Use tax-advantaged accounts like 401(k)s and IRAs whenever possible to grow your money tax-free.

Some tips:

• Hold tax-efficient investments like broad index funds in taxable accounts. Limit bond funds and high-dividend stocks outside retirement accounts.

• Harvest losses in taxable accounts by selling stocks trading below your basis price to offset capital gains.

• Hold assets for over one year before selling to qualify for preferable long-term capital gains tax rates.

• Consider municipal bonds in taxable accounts to avoid federal taxes on interest income.

• Use a Roth IRA or Roth 401(k) for tax-free withdrawals. This avoids taxes on future growth.

Step 6: Monitor Your Portfolio

Check in on your portfolio at least annually or when life changes occur. Over time, your asset allocation may shift away from your targets as some assets grow faster than others. Rebalance back to the desired allocation if significantly out of line.

Also reevaluate your portfolio whenever your situation changes. Things like new career, marriage, divorce, kids, health issues, or retirement may impact your time horizon, risk tolerance, and goals. Adjust your investments accordingly.

Use performance benchmarks like the S&P 500 to measure if your portfolio is achieving expected returns for the level of risk. Underperformance may signal it’s time to change up your investment selections.

Stick to your long-term investing approach through market ups and downs. Avoid the urge to overhaul your portfolio in response to short-term events. Periodically reviewing and rebalancing will keep your investments on track.

Key Takeaways on Building a Portfolio

Starting a portfolio is simpler than it seems once you follow this step-by-step process:

• Know your personal investment profile – time horizon, risk tolerance, goals.

• Choose an appropriate asset allocation across stocks, bonds, and cash.

• Diversify across sectors, geographies, market caps, and investment styles.

• Use low-cost index funds or target date funds to implement your allocation.

• Use tax-advantaged accounts and tax-efficient investing strategies.

• Rebalance periodically back to your target allocation.

• Avoid reactionary changes and stick to your long-term plan.

The key is regularly putting money into your investment portfolio and letting compounding go to work. Over decades, even modest returns can compound into a sizable nest egg.

Stay disciplined, diversified, and focused on the long-term. With the right investment portfolio tailored to your needs, you can steadily build wealth over time.