What is an investment portfolio and how to build one?

Investing is the process of redistributing capital for the purpose of making a profit. If we are talking about investing in shares of American companies, then this is the process of redistributing funds (state or foreign currency) into financial assets (shares). Of course, the purpose of such an action is the ultimate profit.

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

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What is an investment portfolio?

An investment portfolio is a set of shares of companies in which both individuals and legal entities keep their financial assets.

Ideally, the investment portfolio should consist of shares that have a different business model, and the dynamics of price quotes do not depend on each other.

Diversification is the main goal of building an investment portfolio.

Thus, a correction in the stock price for one company will not affect the overall return of the portfolio in any way.

A stock portfolio is considered diversified under the following conditions:

• The company’s shares are traded in different sectors of the economy;
• Companies have different business models;
• Shares are traded on different exchanges or even countries.

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How to form an investment portfolio?

The essence of the formation of an investment portfolio is to ensure your assets against possible exchange rate fluctuations if you invest only in the shares of one company.

As mentioned above, for this it is necessary to diversify the investment portfolio.

But this is not the end of its formation.

We will single out 3 stages for the formation of an investment portfolio:

• Profitability analysis for the selected period
• Analysis of key financial indicators of companies
• Mathematical model

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Profitability analysis for the selected period

Absolutely all stocks that are presented in the eToro Portfolio trading platform are involved in this process.

Profitability analysis is carried out by determining the dynamics of the stock for the selected period.

If the indicator of profitability (stock growth) has a positive result, then they are included in the analysis list.

Note that it is not the dynamics for the year that is taken into account (for example, the fact of growth from January to December), but changes in the context of each day.

So, if a stock closes each trading session in the positive zone on average, it passes the selection of the first stage.

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Analysis of key financial indicators of companies

Only those companies that have passed the previous one take part in this stage.

Here it is already necessary to analyze not the behavior of the share price, but the behavior of the company itself.

Her financial stability. For this, indicators of revenue, net profit, return on shares, dividends, profitability, market expectations and forecasts are taken into account. We have already considered some of these indicators in an article about 7 indicators when choosing stocks.

It should be noted that it is not the fact of the data that is analyzed, but the data for the same period earlier are compared.

If an investor considers a company for investment over a period of several years, then the financial statements of the company should also be studied for the same period.

For example, if you invest in stocks of a company with a horizon of 3 years, then you should analyze the company’s reports for the last 4 years in order to understand the dynamics for the last 3.

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

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Mathematical model

The last stage is fully automated and consists of a mathematical model.

We use the model of building an investment portfolio by Harry Markowitz, for which he was awarded the Nobel Prize.

Therefore, ready-made model portfolios from eToro’s analytical department are called “Nobel portfolios”, because they are completely developed according to the Markowitz mathematical model.

Returning to the construction of the portfolio, the mathematical model takes into account the correlation between assets and reduces it to a minimum value.

The more negatively correlated assets in a portfolio, the more diversified the portfolio will be, as discussed earlier.

As a result, the model itself issues a list of assets in which it is necessary to invest, as well as parameters with which share it is necessary to invest.

That is, the investor receives not only a list of shares for investment but also recommendations with what share of his capital it is necessary to conclude these transactions.

As a result, after selection through three stages, the finished investment portfolio can be sold and rebalance your financial assets into those shares that turned out as a result.

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Investment portfolio example

Table 1. The structure of the optimal investment portfolio

This portfolio demonstrates steady growth, and also consists of shares of those companies that are not interconnected.

That is, companies have a completely different business model and end product or service.

For example, the investment portfolio included shares of companies selling clothes, shoes, coffee, phones and computers and components for them, financial payments, entertainment content and companies earning money from advertising campaigns.

This makes the portfolio balanced and diversified to different sectoral market risks.

It is also worth noting that only those companies were selected that demonstrate a steady increase in both average daily profitability and financial performance.

The stage of selection of shares in the portfolio is finalized by a ready-made mathematical model, which assigned to each share the necessary investment share.

The largest proportion of the portfolio in the shares of Nike and Google: two independent companies from different sectors that do not overlap with each other.

The smallest weight in the shares of Starbucks, due to the strong rise in prices for coffee beans, increases the cost of the final product that the company sells itself.

With a reduction in the cost of coffee beans, the company will be able to generate additional profits and demonstrate excellent results in the future.

However, at the moment it accounts for the smallest share due to additional risks and market expectations.

This is just an example of what assets an investment portfolio can consist of and how exactly you can form it.

It is also worth noting that, depending on 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 allows you to minimize risks, but has the lowest potential for profitability (as a rule, “safe-haven assets” are included in the portfolio structure).

Moderate investment portfolio:

has a balanced structure between “safe-haven assets” and risk stocks that show 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 exclusively of shares of companies that pay dividends constantly and aim to earn from dividends, not exchange differences.

Today, everyone has access to information.

You can also look at the portfolio structure of big-name Hedge Funds or view the structure of Buffett’s investment portfolio.

It is also a practical recommendation to invest in companies that you yourself know and are a user of their products.

In this way, you will be as conscious 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 companies have nothing in common and the same final 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 favorites from just a few different sectors:

• Automotive
• Finance
• Industry
• Consumer Services
• healthcare
• Technologies
• Luxury brands
• Energy
• Consumer goods
• Raw material or mining
• Telecommunications
• Sport

If you experience difficulties in forming your own investment portfolio, eToro’s experts will be able to help you achieve your goals and provide ready-made solutions for investing in stocks.

Statistics, as well as all the information you can see at the link.

For clients of eToro Portfolio trading accounts, an investment portfolio for shares is also available, which will allow you to start earning from investments from the first day.