The investment route to becoming rich envisages investing money in various assets in the hope that that they would appreciate in value over time. When you adopt this strategy to become rich, you would need to create an investment portfolio. The investment portfolio is nothing but a collection of the assets that you own or intend to own. These assets would be purchased with the intention of earning money from them through income or to sell them when their value increases. Creating an investment portfolio is not just making a list of assets. It needs to be prepared after a lot of thought and analysis. This portfolio will make you rich and hence you need to put in time and effort to create it.
Let us look at the steps involved in creating a good investment portfolio that can help you become rich.
- Asset allocation
This is by far the most important part of the process of creating an investment portfolio. There are many assets that you can invest in to make you rich. You need to decide which assets you would like to buy and how much money you would like to allocate to each of these assets. The following are some of the assets that you can consider:
Equity represents ownership of a company. It is generally used to refer to stocks or shares of a company that are owned by shareholders. These shares are traded on the stock market and their price varies depending on many factors including company performance, industry performance and the state of the economy. Shares can increase in price by leaps and bounds. This can help you become rich very quickly, provided you pick the right stocks.
Equity is also used to refer to mutual funds and exchange traded funds. These funds are managed by professional fund managers who use investment collected from the public to invest in stocks (and other options too). If you buy mutual funds, you would be indirectly investing in stocks. The difference is that when you buy stocks the decision is yours, whereas in a mutual fund the decision is the fund managers.
Equity carries risk, as the stock market is volatile in nature. However, staying invested over a long period of time helps to reduce the risk. Historically, investment in stocks and mutual funds has yielded good returns over the long term. It is a good way to earn money and be rich. Your investment portfolio must have equity to help you earn more money.
Debt refers to borrowings made by companies or by the Government. When the Govt. or a company is in need of funds, they can borrow money from the public through the use of various debt instruments. Treasury bills, bonds, debentures, and deposits are some of the debt instruments used to raise funds. A company that needs money for a project or for expansion can offer bonds to the public for sale. You can buy these bonds and are assured of getting interest on the money you invested. The company would invest the money raised through bonds for its work and payout regular interest. Once the term or the bond period is complete, you can redeem the bond to get its value in money.
You cannot earn a lot of money from debt instruments. Generally, they would be around the same that you would earn from banks as interest or a little more. The reason why you need to invest in debt is for safety. Investing in government debt instruments offers 100% safety. Investing in private debt has an element of risk. To reduce risk, you need to look at the credit rating of the bonds and buy only those that are rated highly for their safety.
People invest in debt instruments for capital protection, so that the capital you invest will not be depleted. You can also hope to earn a decent return on your investment. Once again, we must point out that the returns you earn here will probably be half or less than half of what you can earn in the stock market. It is safe and hence preferred by many investors. You must include debt instruments in your portfolio.
These are physical assets like gold, silver, diamond, and other precious metals. They may be purchased in the form of bars or in the form of jewelry (where their value is slightly reduced due to processing). Commodities like gold generally rise in value. It is observed that even if the stock market were down, the value of commodities would rise. This is not a certainty, still it is a good investment to help you balance your portfolio.
Apart from buying commodities physically, you can also buy them virtually through the commodities market. Here, apart from metals you can also buy wheat, rubber, oil, and other such commodities in the derivatives market. You would be not buying to own these commodities but would buy futures and options. This is essentially speculating the future price of these commodities to earn money. It is a risky investment but can help you make money. You can consider this only if you have sufficient knowledge about the market.
- Real estate
Real estate involves the purchase of land and buildings. Real estate, just like other assets would increase in value over time. You can buy property today and then sell it at any time when it rises in value. Unlike the stock market, prices will not be volatile. In general, there is a good demand for real estate, and you can expect very good returns over a long term. If there is a fall in the market, then it may take a very long time for prices to pick up again. Unlike other assets, real estate requires a lot of money to invest. This is an asset you can consider for inclusion in your portfolio.
- Alternative investments
This includes investing in assets that are not conventional in nature. This can include investing in artwork like paintings. These investments are usually done by high net worth individuals. Other such investment options include bitcoins and hedge funds. These can potentially earn you huge returns but are highly risky in nature. They are meant for investors who have sufficient knowledge of these assets.
- Retirement fund
There are some experts who say that a retirement fund is not actually an asset. However, saving money for retirement is one way to become rich. Your employer may offer a retirement plan by which money is deducted from your pay every month and transferred to a retirement fund. The fund would invest your money in the stock market, debt instruments and other options of your choice. By the time you retire, the fund would have grown in value and would help you generate money for your retirement needs. Apart from what the employer provides, there are other retirement accounts or retirement plans that you can consider during the process of creating an investment portfolio.
- Understand your risk
Now that you have understood the different types of assets, where you can invest money, you need to understand about risk. In simple terms, risk is the possibility of your assets losing value. From the above assets, debt instruments have very low risk, especially instruments backed by the government, which have zero risks. All other assets have varying levels of risks. Stocks are risky; but when held over a long period of time can lead to a reduction in risk. Bitcoins and derivatives are very risky. To create a portfolio, you need to understand your risk tolerance.
Risk tolerance is how much risk you can tolerate. If you are not ready to tolerate any risk, then you must invest 100% of your portfolio in debt instruments, and only in government backed debt instruments. The returns you earn here will be less, but there is no risk. If you ready to take a little risk, you can invest in private debt instruments. The higher the risk you are ready to tolerate, the more diverse your portfolio can be. Based on how much risk you are ready to tolerate; you can be classified as:
- Aggressive investor: is ready to take more risk. If you are in this category, you can invest more money in stocks and in real estate and derivatives.
- Balanced investor: is one who is willing to take a risk in return for reward. However, this type of investor would want to invest some money in safe options to balance the possibility of losses from aggressive investments.
- Conservative investor: This investor is more interested in protecting capital and would be willing to take low levels of risks by investing little money in stock/real estate.
- Safe investor: is one who is not ready to take any risk and is happy investing all the money in debt instruments.
- Create your portfolio
Having understood the types of assets and risks, it is now time to allocate money for assets and create a portfolio. If you are confused about the process, you can meet a financial advisor who can help you understand your risk tolerance and then advise you on how to allocate assets. If you are confident that you can do it on your own, then you can consider the ‘100 minus age’ rule. This rule states that you should invest 100-your age in equities. If you are 30 years old, you can invest 70% of your money in stocks and mutual funds and the rest in debt instruments. This is just a thumb rule; you can follow the pattern of investment that suits you.
Before you start allocating assets, you need to identify your investment goals. You are investing money to become rich; but how much money do you need? When do you need the money and what for purpose? The answers to these questions would help you decide your investment goals. For instance, you may need 100,000 in five years to buy a new house. This could be one investment goal. You may need a million in 25 years for your retirement. This could be another investment goal. Here, you can consider your retirement plan and also invest additionally to meet your target.
When you carry out asset allocation, you need to keep an important principle in mind, which is asset diversification. Diversification is spreading assets across different types to reduce risks. For instance, your asset allocation may look something like this:
- Real estate – 100,000
- Stocks – 100,000
- Large cap stocks – 50,000
- Mid cap stocks – 20,000
- Technology stocks – 20,000
- Small cap stocks – 10,000
- Debt – 30,000
- Bonds – 20,000
- Bank deposit – 10,000
This is an example of a diversified portfolio. You are investing in different types of assets and within each asset, you are further diversifying. When you buy stocks, you can invest in large cap funds of top companies that are usually safe. You can invest in mid cap funds that can be volatile but can earn you more returns. Since technology is popular, you can invest some money to buy stocks of technology companies. Small cap funds are low cost stock investments where you can gain huge returns or lose a lot of money. Diversifying your investment creates a balanced portfolio where the risk is reduced.
- Start investing
Once you create the portfolio, you can then start investing. For this, you may need to open a brokerage account to buy stocks/mutual funds. Make sure you stick to the portfolio you have created and invest money as per your plan. Periodically, you may need to rebalance your portfolio. This is required to remove assets that are deadwood and is not generating returns. You can replace such assets with better ones.
When you create an investment portfolio wisely, you can look forward to earning money from it and becoming rich. Some of the investment types like real estate can generate regular rent. Similarly, stocks can generate dividend. It would be better to reinvest this money to buy more assets. This will help you earn more money, to achieve your goal of becoming rich.