How to develop a good investment portfolio

Every investor should analyze their personal circumstances and objectives before developing their portfolio.

We understand an investment portfolio as a set of financial assets that are diverse in nature, in which a natural or legal person invests. The enormous diversity of financial assets means that there are an almost infinite amount of investment portfolios, balanced out in different ways according to the types of asset, currency, geographical area, etc. An investment portfolio, in the broadest sense of the term, can include non-financial assets such as real estate or works of art.

It is essential that every investor, ideally with the help of a financial planning professional, builds his/her own investment portfolio, customized to the specific needs, time frames and risk profile. There is no single investment portfolio that is well suited to two different investors.

To develop and investment portfolio, it is a good idea to answer a range of questions and take certain things into account, which we are going to look at here.

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Why am I going to invest?

It is essential to set an objective. It is possible that we end up running the risk of investing in assets that, whether due to liquidity or their risk profile, are not suitable for our true needs. Investing in a retirement plan, an objective that can be extended over more than three decades, is not the same as saving to buy a new car, something that might be done over five years or so. The timescale is a critical variable.

An investor's risk profile is closely linked to the investment timescale. Someone who invests with a twenty-year timescale in mind can run more risks than someone who invests over two years, for the simple reason that there is a greater margin for maneuvering, and because the volatility of high-risk assets tends to be diluted in the long term. Nevertheless, the perception of risk is subjective and there are people who are more risk averse than others. Therefore we need to answer questions like 'what are my expectations for returns', or 'what is the maximum level of loss that I am willing to handle'. These answers determine whether we are conservative, moderate or aggressive investors.

Diversification

This is one of the main principles of investment if we want to minimize risks. If we concentrate the whole investment into one asset we are only subject to one source of returns. If this asset behaves negatively we will have committed all of our capital. By diversifying across various assets we reduce the risk, and so the potential negative behaviour of one of them would be lessened by the evolution of the others.

It is a good idea to diversify types of asset and, within each type, the different options. For example:

  • We can channel the saving for retirement through pension plans or insured employee pension plans, which also provide tax benefits.
  • Through investment funds, we can channel savings to more short term through fixed-income, low-volatility investment funds, and channel the more long-term savings into mixed or equity investment funds, which are more volatile in the short term, but which are generally much more profitable in the medium and long term.
  • As well as for channeling savings, we can also use insurance to cover contingency the contingency of death, for our family's future peace of mind.

 

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Paying attention to taxation

Sometimes, when we analyze the behaviour of an investment portfolio, we go straight to looking at the returns on each of the assets and the weighted returns of the portfolio. This is not wrong, but it really is the final stage. Investment products are subject to taxation, and so the final returns will be what we refer to as financial-fiscal returns, i.e. the returns net of any tax obligations. Let's look at a couple of examples:

  • Penion plans allow for annual deductions of the contributions made (up to a maximum of €8,000). However, it is very important to properly plan their redemption to minimize the tax bill, given that the provisions are considered compensation for work.
  • Investment funds are generally one of the protagonists in investment portfolios, as transfers between them have no fiscal impact, which is deferred at the time of redemption. In this respect it is possible to manage a portfolio actively for years without having to be accountable to the government.
  • Life annuities are interesting reduction coefficients, which are greater the older the policyholder. For example, people over 70 are only taxed on 8% of their income.
  • The direct investment in stock has the same tax consideration as investment funds, with the difference that there is no tax exemption in how they are managed as it is not possible to make transfers between stocks.
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