Building a portfolio: how to leverage multiple investment options to diversify and build the right portfolio

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26-year-old Ashima is getting ready for the vacation of her dreams - her first solo trip abroad. She’s booked her flight tickets, picked and paid for her accommodation and even made an itinerary of all the places she’d like to see. Now, she’s just got one thing left on her to-do list. Packing. 

She has a couple of suitcases open before her. Quickly sorting through her wardrobe, Ashima picks a couple of dresses, some pants, a few shirts and tops and even a pair of hats. She tops these off with some beachwear and sunglasses. And of course, she throws in some other essentials. 

In a similar manner, you too can build an ideal investment portfolio with the many different investment options available. And now that you’ve been properly introduced to almost all of the major types of investment options out there, it is time to learn how to build your portfolio of your own. 

To begin with, let’s first take a look at the returns offered by various investment options. 

A comparison of returns 

Say on April 1, 2010, you invested Rs. 100 each in different investment options. The comparison table that we’ve compiled showcases just how much your investment would have changed on April 1, 2019. 

To make it even easier for you to understand this, we’ve lined up the investment options in the order of increasing risk, with the least risky option at the top and the most risky option at the bottom.

Investment option

As on April 1, 2010

As on April 1, 2019 

10-year government bonds

Rs. 100

Rs. 196.68

Fixed deposits 

Rs. 100

Rs. 199.30

Gold

Rs. 100

Rs. 175.36 

Performance of the Nifty 50 index (equity)

Rs. 100

Rs. 220.74

Crude oil (commodity)

Rs. 100

Rs. 83.54 

U.S. Dollar (currency)

Rs.100

Rs. 168.46

Just by looking at this comparison table, you can see that with the sole exception of crude oil, all the other investment options have performed admirably well. And as we’ve learnt in the previous chapters, equity, in particular, has managed to outperform every other asset class by a significant margin.

Building the right portfolio 

So, you saw how the returns of different investments vary over the same period. Given this information, let’s see how you can leverage multiple investment options to build your ideal investment portfolio. But before that, there’s an important question that’s looming in closer. What is an ideal portfolio anyway? In layman terms, an ideal portfolio is one that gives you the returns you need, within the timeframe you need them.

To build your portfolio, it is essential to not just focus on the returns offered by the investment options, but also equally consider other factors such as risk, liquidity and volatility.

Building and diversifying a portfolio on the basis of risk tolerance

As an investor, based on your risk tolerance levels, you can be broadly classified under the following three categories. 

  • Conservative investor (low risk tolerance)
  • Moderate investor (moderate risk tolerance)
  • Aggressive investor (high risk tolerance)

Here’s how you can build and diversify a portfolio according to your level of risk tolerance.     

Conservative investor  

You’ll recall that you come under the ‘conservative investor’ category if you’re an investor who is averse to risk and generally prefers to play it safe. In this case, you’d be better off investing a greater proportion of your capital in safe bets such as government securities and fixed deposits and less on equity and real estate. This way, you not only achieve your goal of diversifying your portfolio, but also get to stay well within the level of risk you’re willing to take.

Moderate investor

If you don’t mind taking risks every now and then, but still prefer to stay focused on preserving your capital, you’re generally regarded as a ‘moderate investor.’ One of the ways in which moderate investors can build a diversified portfolio is by equally allocating the investment capital towards low risk and moderate to high risk investment options. 

For instance, let’s say that your capital is Rs. 1,00,000. As a moderate investor, you could perhaps invest Rs. 25,000 in gold, Rs. 25,000 in PPF and Rs. 25,000 each in equity oriented mutual funds and corporate debt securities. This is just one of the many ways in which you can build the right portfolio. Given your capital and the investment options out there, the combinations are many.     

Aggressive investor

As we saw in an earlier chapter, you’re classified as an ‘aggressive investor’ if you have a high tolerance for risks. Aggressive investors generally don’t shy away from investing in risky options such as derivatives and foriegn currencies. Considering this, such an investor can allocate a greater proportion of their capital towards risky investments and a small portion towards safer and more stable options. 

Let’s say that your friend Shyam, who is an aggressive investor, also has Rs. 1,00,000 as his investment capital. Given his risk profile, he may be more inclined to invest a greater portion, say Rs. 75,000, in a mix of equity, commodity and derivative investments, while allocating the remaining Rs. 25,000 towards a mix of gold and NPS schemes. 

Again, this is only an illustrative combination and certainly not the only way to invest the given capital. 

Building and diversifying a portfolio on the basis of investment horizon  

In this segment of our lesson, we’ll focus more on creating a portfolio according to the investment horizon, while still accounting for risk.   

Short-term investment horizon

If you’re a conservative investor with short-term goals, you could build a portfolio with greater emphasis on short-term, low-risk instruments such as gold, fixed deposits and treasury bills. In addition to this, you could also invest a smaller portion of your capital in the equity market or corporate debt market with a long-term view to balance out and diversify your portfolio.      

Conversely, if you’re an aggressive investor, your portfolio could contain short-term, high-risk instruments such as ELSS and direct equity. And, to diversify, you could also add in a mix of government bonds and PPF investments with a long-term view.

Long-term investment horizon

Going by the same logic, a conservative investor with long-term goals would be better off creating a portfolio with a large portion of their capital invested in long-term, low-risk instruments such as 10-year government bonds, PPF, NSC and NPS. For the purpose of diversification, a portion of the capital could also be invested in short-term instruments such as ELSS. 

Likewise, an aggressive investor would do well with a portfolio where long-term, high-risk instruments such as corporate debt and equity-oriented mutual funds form a major part of their investments. Short-term, low-risk options such as gold and fixed deposits could make up the rest of the portfolio.

Wrapping up

With this chapter, we hope you’ve gotten the hang of how to build a portfolio by leveraging multiple investment options for optimum diversification. Later, in the module related to personal finance, you can build up on this knowledge to get better at building and managing your ideal investment portfolio

In the following lessons, we’ll see a bit more of portfolio management and some common errors that new investors tend to make. Stay tuned!    

A quick recap          

  • You too can build an ideal investment portfolio with the many different investment options available.
  • When building a portfolio, it is essential to not just focus on the returns offered by the investment options, but also equally consider other factors such as risk, liquidity and volatility.
  • As an investor, based on your risk tolerance levels, you can be broadly classified under the following three categories: conservative investor (low risk tolerance), moderate investor (moderate risk tolerance), or aggressive investor (high risk tolerance)
  • You also need to factor in your investment horizon when building a portfolio. 
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Comments (1)

Atharva Patil

27 Nov 2020, 04:25 PM

By the first example I imagine Ashima is too hot😂

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