Investing Classroom: Steps to a suitable portfolio

Putting together a portfolio of securities is like building a wardrobe. Even if your wardrobe is filled with top-of-the-line attire, that may not be enough: All those components need to work together as outfits. Investment portfolios work in the same way.

This track of the Investing Classroom will show you how to design a successful portfolio of investments that work together to help you reach your goals. In this course, we'll introduce the five essential steps to tailoring your portfolio and keeping it in good shape. We'll expand on these steps in subsequent courses.

Create a pattern
Just as a tailor making a suit starts with a pattern, you need a pattern for your portfolio. The tailor's pattern fits an individual of a particular size and shape. Similarly, your portfolio should fit you.

A good fit starts with your investing goal. Maybe you're investing for retirement, for your child's education, or for a holiday home.

Whatever your goal, it gives you vital information. It tells you how long you'll be investing (your time horizon), and how much of your investment you can put at risk. The closer your goal or the less you can afford to lose, the more you should focus on preserving what you've made rather than on generating additional gains.

How much should you put into cash, bonds, and various types of stocks? One rule of thumb is to use your age as a guide. For instance, if you're 33 years old, put 33% of your portfolio into cash and bonds and the rest into stocks.

Some investors would find that figure awfully conservative, though. Others might find that it's too aggressive for their particular goal. Such rules are like buying a one-size-fits-all shirt--sure you can wear it, but does it really suit you? Probably not. We'll show you how to determine what cash/bond/stock mix is right for you in upcoming lessons.

Discover what you already own
Maybe you can name all of your stocks and funds off the top of your head and detail how each one performed last week. Good for you. But can you explain how they work together? Which are your core investments? Are you diversified? Do you have a lot of overlap? You must be able to answer those questions before you can see how (or even if) your portfolio fits your pattern.

To figure out exactly what you own, you could buy a financial calculator or investing spreadsheet, haul out the latest shareholder reports for your funds and account statements for your stocks, and calculate how much you have in cash, bonds, and various types of stocks. What a job! No wonder people don't know what's in their portfolios.

Use Morningstar.co.uk’s Instant X-Ray tool instead. Simply enter the tickers of all of your investments and how much you have invested in each, either in pounds or percentage terms.

You'll discover your portfolio's asset mix, style-box breakdown, sector weightings, regional exposure, and much more. For ongoing monitoring, you can save your portfolio in Portfolio Manager.

Make your portfolio fit your pattern
Now that you know what you have, it's time to find out whether your current portfolio fits your pattern.

Begin by checking your portfolio's asset allocation. If that doesn't match your pattern, shift assets among funds and stocks to tailor the mix.

Next, weed out redundant investments. If you have three large-cap growth funds, for example, they probably aren't all equally good. Refer to Morningstar’s fund reports to see which fund has the best category ratings and lowest expenses. This article provides some tips on how to navigate our reports and which questions you should be asking.

Be sure that your portfolio includes core holdings, those investments on which you're relying most to help you meet your goals. Core investments should be the biggest part of your portfolio. We'll discuss how to choose them in later lessons but in the meantime you may want to check out this article on finding a core stock fund.

Finally, fill any portfolio holes, such as a lack of value or foreign exposure, with new investments.

Schedule a time to rebalance
By following the first three steps, you've tailored a portfolio that suits you to a T. You'll want to make sure that it continues to fit, though. That requires occasionally rebalancing, or restoring the original pattern.

Stocks often gain more than bonds or cash. As a result, stocks will probably take up more of your portfolio over time than in your original pattern. Because stocks are riskier investments than bonds, your portfolio is becoming riskier as your stock position rises. That's why it's important to rebalance and restore your portfolio to its original pattern.

Similarly, not all stocks do well at the same time. Maybe your value stocks are outpacing your growth investments. If you don't restore your portfolio's original balance between the two styles, your investment success will become increasingly dependent on your value investments.

When you rebalance, keep your goal in mind. As you get closer to needing the money you've invested, the pattern you originally drew should change. Your portfolio should become more conservative as you approach your goal.

Monitor your investments
In addition to rebalancing your portfolio, you'll want to keep tabs on your individual investments. You need to make sure they're still filling their original roles in your portfolio.

Let's say you're monitoring your funds. What types of things should you look for? Make sure your funds stay in the same Morningstar category; if a fund's style has changed dramatically, the fund may no longer meet your needs. Examine the fund's category rating--is it still competitive? Watch out for manager changes, too.

With stocks, you'll want to keep tabs on price, and where that price is relative to the sell target you've established. Changes at the top matter too--new management can mean new strategy. Profitability, financial health, and growth prospects are also all important.

For more Investing Classroom lessons, check out our Learning Centre by clicking here.