What is an investment portfolio and how to build one?

Investment is the process of redistributing capital in order to make a profit. When it comes to investing in shares of American companies, it is the process of redistributing cash (state or foreign currency) into financial assets (shares). The goal of this action is undoubtedly the ultimate return.

The goal of every investor is to find the most attractive stocks for long term savings and to create an effective investment portfolio.

What is an investment portfolio?

An investment portfolio is a selection of shares of companies in which both private individuals and companies hold their financial assets. Ideally, an investment portfolio should be made up of stocks that have different business models and price volatility.

Diversification is the primary goal of an investment portfolio. Thus, a correction in the share price of one company will have no impact on the total return of the portfolio.

A portfolio of stocks is considered diversified under the following conditions:
A company's shares are traded in different sectors of the economy;
Companies have different business models;
Shares are traded on different stock exchanges or even countries.

How to form an investment portfolio?

The essence of forming an investment portfolio is to insure one's assets against possible exchange rate fluctuations by investing only in shares of one company. As mentioned above, this requires diversification of your investment portfolio. But this is not the end of its formation.

We will distinguish 3 stages in the formation of an investment portfolio:

Analysis of returns for a selected period

Analysis of key financial indicators of the companies

Mathematical model

Analysis of return for selected period

This process involves absolutely all shares, which are presented in the trading platform Libertex Portfolio. Analysis of the yield is carried out by determining the dynamics of the share for the selected period. If the stock has a positive return (growth rate), then it is included in the analysis list. Note that it is not the trend over the year (for example, the fact of growth from January to December) that is taken into account, but the change on a daily basis. For example, if a stock closes each trading session on average in the positive zone, it passes the first-stage selection.

Analysis of companies' key financial indicators

Only those companies which have passed the previous stage participate in this stage. It is no longer the behavior of the share price that should be analyzed here, but the behavior of the company itself. Its financial stability. For this purpose, we take into account revenue, net income, return on equity, dividends, profitability, market expectations and forecasts. We have already looked at some of these indicators in our article about 7 indicators for stock picking.

It is worth noting that it is not the data itself that is analyzed, but rather a comparison of data from a similar period previously. If an investor is considering a company for investment over a period of several years, then the company's financial statements should also be studied for the same period. For example, if you invest in a company with a horizon of 3 years, you should look at the company's reports for the last 4 years to see how the company has evolved over the last 3.

Only those companies which have a steady growth in financial performance and show a growth in profit from quarter to quarter, year to year, pass to the next stage.

Mathematical model

The last step is fully automated and consists of a mathematical model. We use Harry Markowitz' investment portfolio construction model, for which he won the Nobel Prize. That is why the finished model portfolios from our analytical department are called "Nobel portfolios", because they are fully developed according to Markowitz's mathematical model.

Going back to portfolio construction, the mathematical model takes into account the correlation between assets and reduces it to a minimum value. The more assets in the portfolio with a negative correlation, the more diversified the portfolio will be, as we wrote about earlier. As a result, the model itself produces a list of assets to be invested in and the parameters of how much should be invested. In other words, the investor will not only receive a list of assets to invest in, but also a recommendation about how much of their capital they should invest.

As a result, after the selection in three stages the finished investment portfolio can be sold and rebalance your financial assets into the resulting shares.

Example of an investment portfolio.

Source: https://www.wallstreetzen.com/blog/example-stock-portfolios/

It is also worth noting that for the type and nature of investments, the portfolio can also be divided into 4 categories:

Conservative investment portfolio: has the safest assets in its composition, which minimises risk, but has the least potential for return (as a rule, the structure of the portfolio includes "shelter assets").
Moderate investment portfolio: has a balanced structure between "safe haven assets" and risky equities that exhibit stable returns.
Aggressive investment portfolio: consists of stocks of companies that have steady growth as well as assets that have high growth potential, but carry additional risks.
Dividend investment portfolio: consists solely of stocks of companies that consistently pay dividends and aim to earn from dividends rather than exchange rates.

Today everyone has access to the information. You can also look at the structure of the portfolios of prominent Hedge Funds or see the structure of Buffett's investment portfolio.

A practical recommendation would also be to invest in companies that you yourself know and are a user of their products. That way you will be as deliberate as possible in choosing stocks to invest in and adding them to your portfolio. The main thing to remember is to diversify by sector so that the companies have nothing in common and the same end product. There is no economic or financial benefit to adding Mastercard and Visa or Coca-Cola and Pepsi stocks to your investment portfolio. It will be enough to choose your favourites from just a few different sectors:

Automotive
Finance
Industry
Consumer Services
Healthcare
Technology
Luxury brands
Energy
Consumer Goods
Raw materials or mining
Telecommunications
Sports