An investment portfolio is basically a collection of assets owned by an individual or institution designed to grow in value or provide income. Typically, an investment portfolio is well-diversified, and may contain many different types of assets, including cash, real estate, and gold. Most commonly, however, an investment portfolio will contain stocks and bonds whose overall value fluctuates depending on market performance. Most individual portfolios contain a wide range of assets designed to provide a long-term gain for things like retirement or children’s inheritances. There are several different types of investment portfolios, and each of them have different impacts.
Tax-Managed vs. Tax-Deferred Investment Portfolios
Whenever you are making money, you are going to have to pay taxes which are unavoidable. When it comes to investments, however, the question arises: when do you want to pay those taxes? Some portfolios are taxable or tax-managed. This means that you pay taxes each year on any income you get from those investments or any gains you might make from selling various assets. A tax-deferred account, however, is one that does not require you to pay taxes until you actually start to make withdrawals.
That might sound good, but many people still opt for the taxable accounts, because in this case you’re getting the taxes out of the way now. This makes it easier in many respects to manage and plan your finances. Should you retire wealthy and in a higher tax bracket, for example, you could be paying more taxes in the future than you would now. In addition, certain types of assets are taxed at a lower rate, which means paying the taxes now might be more advantageous.
Active vs. Passive Investment Portfolios
Another major distinction in investment portfolios is whether they are managed actively or passively. You can get a good idea of what that means by the name itself. An actively managed portfolio is a portfolio that has an investment manager whose job it is to buy and sell in an effort to make as much money as possibly. This means that assets are traded constantly. This can be great, if wise decisions are made and the market performs well. However, at the same time, a poor decision or an inept manager can mean losing money. Keep in mind that the investment manager gets paid either way, so some of the money you’re hoping to make goes to pay his fee.
A passive portfolio, on the other hand, runs more along the lines of “set it and forget it.” The investments are set up usually to mimic one of the major stock indices and then they are more or less left alone. This is much easier to manage because you don’t have to worry about the day-to-day aspects of trading. In addition, you don’t have to worry about all those fees going to an investment manager. Of course, with a passive portfolio you’re more or less at the whim of the market. A bad week or month (or longer) can mean a significant loss, and while the markets usually recover, you’re still left with less than you could have.
Focused vs. Diversified Investment Portfolios
You may have heard the advice to keep your portfolio diversified. By diversification, we mean getting exposure to a wide variety of industries and sectors and asset types, so bad performance in few of these assets is counterbalanced by good performances in other assets, and the overall portfolio remains relatively stable.
The advice to invest in index funds, in addition to its being passive, also hinges on the fact that index funds get you instant diversification. However, it is counterproductive to have portfolios that are over-diversified. Beyond a certain point, additional diversification does not bring any more benefit, and only forces you to buy assets that may not be worth it, just in the name of diversification.
A focused portfolio with only a limited number of investments, on the other hand, provides you the opportunity to pick and choose what you invest in. You are also more likely to keep close tabs on the investments and the business performance of your companies, if you have a limited and manageable number of them to monitor.
Your investment decisions when you run a focused portfolio are mostly based on the merits of the investments you hold, and are therefore less likely to be at the whims and fancy of the market, and more under your control.
Investing can be challenging for those in their mid-20s to mid-30s. It can be especially daunting to try to build a portfolio from scratch. Thus, here are more tips to help you with it.
“He who earns and does not invest will have to work for the rest of his life.”-Debasish Mridha
