A portfolio of investments is a combination of different investment assets. Its purpose is diversification. As different securities perform differently at any given time, having diverse combinations makes you less prone to an overall loss. When for example stock prices drop, bond yield might rise and make up for the shares capital loss.
An investment portfolio can include not only financial assets, such as cash equivalents, stocks, bonds but also alternative investments like futures and options. Some portfolios hold in addition real items like art, real estate, precious metals etc. There are several types of portfolios that consist of different proportions of assets, which depend on the profile of the investor and his goals. Portfolios may be held by individual investors, but also can be managed by financial professionals, banks, hedge funds and other institutional investors.
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Each investor forms a portfolio, which suits his needs and risk profile. The monetary value of each asset influences the risk-reward ratio of the portfolio and is referred to as asset allocation of the portfolio, which aims at maximizing profits while minimizing risk exposure. Like many guides suggest, the best way to imagine what a portfolio looks like is to think of it as a pie chart, like the one below.
Each section of the chart corresponds to a different asset. According to the choice of asset allocation, an investor can build up several types of portfolios, which generally follow two basic directions – conservative and aggressive.
The conservative concept operates in a much shorter time-horizon and puts safety as a main priority. It is most appropriate for risk-averse investors who rely on sure and regular short-term cash flows. Such portfolios mainly consist of cash, cash equivalents and quality fixed-income instruments. Their main goal is to maintain the real value of the portfolio by protecting it from the inflation.
The aggressive concepts are mostly suitable for risk-prone investors, who aim at the highest possible profit. Such market players have a high risk tolerance and their goal are high returns over a long-term period, mainly from equities.
Following the above noted basic concepts of portfolio forming, we can further look into a more detailed, but still overall common classification of portfolio types and suggest five of those – aggressive, conservative, hybrid, income and speculative portfolio.