What are the General Principles of a Portfolio?
To understand stock market portfolio basics for beginners, one must first determine what goals an individual or institution has for the investments. They must also know how to manage the mixture and properly maintain the necessary diversification. Although a standard mix of investments found in a portfolio can provide the same amount of risk as many other individual securities, professionals usually point to the concept as a viable way to mitigate losses in a volatile market. In theory, when an investor balances a portfolio with a proper mixture of assets, some will be successful and some will not. This means that the overall value of the portfolio will increase in the long run.
Types of Assets in a Portfolio
The most simplified understanding of stock market portfolio basics for beginners involves knowledge of the different types of securities available to investors. Portfolios generally contain a proper mixture of stocks, bonds, precious metals, futures, options and real estate.
A basic addition to a standard portfolio is capital stock. Usually allocated to a portfolio via stock certificates, these securities represent a capital investment into a company. The stock certificate does not necessarily represent the actual assets or property of the business, but rather the overall value of a portion of the firm.
Bonds are contracts that require an entity to repay the principle with interest at a specific date. These can include certificates of deposit (CDs) or commercial paper. They act essentially as a loan issued by a borrower. The creditor is the holder of the loan, represented by a bond certificate. These bonds can be sold by the originator and purchased for a portfolio, representing a long-term investment that is generally secured as a profitable investor.
Precious metals are usually included in a portfolio by means of gold, silver or platinum certificates. Traditionally, these were issued by governments, however, modern certificates come from private companies holding the gold in its tangible form. The overall benefit of precious metals in a portfolio is the fact that they generally rise in value over time and can be considered secured investments during a volatile market.
Futures contracts as part of a portfolio can be a highly-valued option for investors. As a type of derivative, futures are essentially agreements that give an entity the right to buy or sell a security at a future date or at a specific price. Again, this results in an investment option with minimal risk.
Similar to futures, option contracts give either a buyer or seller the right to purchase or sell an asset before the expiration of the contract. Call options are for the buyer, while put options are for the seller. This is another portfolio component with minimal risk.
However, a final component that investors needing information on stock market portfolio basics for beginners needs to understand is the addition of real estate into the mix. Real estate represents tangible property such as land or buildings. While this can often result in some of the greatest opportunities for profits, it can also result in major losses when the real estate is found to be a poor choice.
Above left: Consolidation Bond. (Supplied by Struthious Bandersnatch at Wikimedia Commons; Public Domain; https://upload.wikimedia.org/wikipedia/commons/f/f7/South_Carolina_consoliation_bond.jpg)
Stock Market Portfolio Strategies
Using the concept of valuation, the major stock market portfolio basics for beginners involve different financial models with which to arrange a proper mixture depending on the needs of the investor.
Developed during one of the fastest-growing economic advances in American history, the 1950s to the 1970s, modern portfolio theory uses the concept of maximization on returns and minimization of risk. The overall idea is to have a generally low risk mix in the portfolio that will most likely generate a substantial gain. Essentially, one security’s loss will be offset by gains in another. For example, as stocks fall, bonds generally rise. Finding the right diversification results in high levels of profit.
Other models use equations that take into account different attributes of the stocks such as the overall market, the exact value of the asset and unexpected potential to find the correct investments. By using these factors, investors can find the best portfolio options to mitigate risk and expand return. Examples include the single-index, Jensen Index, Treynor Index and Sharpe Diagonal models.
Still another management practice for a portfolio is the capital asset pricing model. This is used to determine the benefit of adding another asset to an already well-diversified mix. Basically, the rate of return is determined and balanced with the likely risk of the security.
The one major factor to consider when learning the stock market portfolio basics for beginners, is to seek out a financial professional to assist in developing and managing the assets. A well-diversified portfolio can be a challenge to develop. Only a professional can help a new investor to find the right balance that will be the most beneficial to their financial future.
“Portfolio Basics” MSMoney: https://www.msmoney.com/mm/investing/portfolio_basics/portfolio_basics_intro.htm
“How Do I Build an Investment Portfolio” MSN Money: https://investored.money.ca.msn.com/managing-your-money/planning/investing-basics/Pages/how-do-i-build-an-investment-portfolio.aspx
This post is part of the series: Learning Investment and Portfolio Managment for Beginners
There are a number of theories regarding setting up a basic investment portfolio when you are first getting started in the market. Strategies such as modern portfolio theory or the single index model can help you choose the best stocks, bonds and derivatives to include in your portfolio.