How to Make Money Work For You: The Guide on Building a Portfolio

Making your money work for you is the best way to make a profit. Many people work hard for their money and put it in a bank, which pays them next to nothing interest on what they have saved. This is a waste of your hard-earned cash as you can make an average return of 5-8% on investments that will beat inflation and gains from the stock market, property, and cash in the bank. Here’s how to build an investment portfolio. 

Have An Investment Policy Statement

First, you must consider what sort of investor you are and this will dictate the types of investment opportunities that will suit your style. This is known as your ‘Investment Policy Statement’ (IPS). When it comes to investing, this is essential as the IPS will help you define how much risk to take, what investment timeframe you are aiming for, and how much regular income you will need from your investments. To illustrate how to do this properly, here are some examples of IPS statements.

Jim’s Investment Policy Statement: My goal is to replace my current income within 2 years to reduce dependency on wages for survival and wages will be the last priority after bills and retirement savings. I aim for investments that pay dividends (e.g. dividend stocks, REITs, high-interest savings accounts) to provide me with monthly income. I want my retirement nest egg to have a steady build-up over the next 15 years. I do not need or expect capital growth on this account as it is purely for retirement and therefore risk is low to medium, but no more than that because I may need to withdraw money from it before I retire.

Mary’s Investment Policy Statement: My goal is to eliminate all my debts and provide a steady stream of income over time, as well as to reach financial independence within 10 years. I aim for investments that pay dividends (e.g. dividend stocks) to provide regular income for bills and emergencies. I want my investment portfolio to have a steady build-up over the next 10 years. However, in the short term (i.e. next 1-2 years) I am prepared for possible losses of up to 30%.

The Types of Investments to Build Your Portfolio

Once you have defined your own Investment Policy Statement, it is time to know what types of investment opportunities are available in line with your objectives. Here are some types of investments:

· Bonds – This is an investment in debt financing of a business, government, or government agency. Although the risk of default is low (although it has happened), bond prices can fluctuate with changes in interest rates and inflation. However, if you plan to hold them for a long term (i.e. longer than 1 year) then their fluctuations will not affect your portfolio much. The best-fixed income bond would be government bonds of major developed countries. In this case, there is a low risk of default and the return will depend more on inflation rather than interest rates.

· REITs – Real Estate Investment Trusts (REITs) are companies that invest in real estate and can offer high dividend yields. You can buy shares through a broker and the share price will go up and down like any other company. However, they tend to be more stable than most businesses. As there is no direct control over what these companies do, the risk factor is higher than investing directly in property but the returns (net of costs) are higher as well, usually between 5-10%.

· Equity – This is an investment in shares of a company, which may offer high returns but also carry considerable risk due to the fluctuations in prices. Thus these should only form part of your diversified portfolio rather than making up the bulk.

· Dividend Stocks – These are shares in companies that offer dividends to their shareholders. This is because their profit margins are typically high, so they have the cash flow to pay out these dividends regularly. For this reason, you can expect an annual dividend yield of 2-4% each year for this type of investment. Dividend stocks offer capital growth if you continue to hold the stock and wait for it.

Keep Costs and Taxes Low

Once you have decided on the type of investment to make, it is time to evaluate the costs and taxes associated with it. Over a long period of time (more than 5 years), fees can eat up a large proportion of your returns. This is why choosing the right fund manager or broker who charges low fees (e.g. 1% fee) is important because, at the end of the day, it all comes down to the return that you get after deducting all fees and taxes.

No matter your investment objectives, time horizon, and risk-aversion tolerance, diversification is key to minimizing the risks of a portfolio. Once you have decided on what types of investments to make, it is important to keep costs and taxes as low as possible.

About Post Author

Pluralist

See author's posts