Building Your Investment Portfolio from Scratch: A Simple Guide

When it comes to building an investment portfolio from scratch, it can often feel like you're stepping into uncharted territory. The world of investing is filled with jargon, theories, and endless possibilities, but it doesn't have to be overwhelming. We're here to simplify the process and help you make informed decisions that align with your financial goals.

Understanding Portfolio Theory: In Simple Terms

Let's begin with the essentials. One of the core principles of investing is the relationship between risk and return. In simple terms, achieving higher returns requires accepting a certain level of risk. On the other hand, seeking complete safety often results in lower returns. If someone promises high returns with minimal risk, it’s wise to approach with scepticism.

Enter Modern Portfolio Theory (MPT)—a framework that helps investors balance risk and return by diversifying across various asset classes that don’t always move in tandem. The objective is to create an “efficient frontier,” optimizing returns for the level of risk you’re comfortable with. Diversification, often referred to as the only "free lunch" in finance, reduces risk without necessarily compromising returns. It’s a robust strategy to help your portfolio endure different market conditions.

But what does diversification actually entail? And how do you construct a portfolio that aligns with your financial objectives? Let's delve into the details.

The Three Drivers of Asset Allocation

Crafting an effective investment portfolio begins with a clear understanding of three pivotal factors:

Your Goals: Whether financial or personal, your goals will fundamentally shape your portfolio's structure. Are you saving for retirement, purchasing a home, or funding your children’s education? Defining your endgame is essential.

Your Risk Appetite: Risk tolerance varies from person to person. It's one thing to claim comfort with risk, but how did you react during past market downturns, such as the sharp pullbacks of 2022 or the financial crisis of 2008? Did you remain steadfast or panic and sell? Accurately gauging your true risk tolerance is crucial for building a portfolio you can maintain through all market conditions.

Your Time Horizon: Conventional wisdom suggests that younger investors should adopt a more aggressive stance, given they have more time to recover from losses, while older investors should lean towards more conservative allocations. This is where the common rule of thumb comes into play: allocate a percentage of your portfolio to bonds equal to your age, with the remainder in stocks.

A thoughtful blend of these factors will help determine the optimal asset allocation for you.

Creating a Simple Investment Portfolio

If you’re just starting on your investment journey, keeping it straightforward can be an excellent strategy. Let's say you've determined that a 60/40 split between stocks and bonds aligns well with your risk tolerance and financial goals. The next decision is how to allocate your investments within those categories.

Stock Allocation:

Instead of attempting to pick individual stocks, consider investing in funds that offer broad market exposure. You might think about whether to focus solely on local stocks or include international ones. Limiting yourself to just one country's stocks can reduce diversification, as some markets are heavily weighted toward certain sectors. For instance, Australia's market, which represents a small fraction of the global market, is predominantly concentrated in sectors like banking and mining. To achieve a more balanced portfolio, consider a mix of both local and global stocks. This approach provides wider exposure to various industries and geographies, reducing the risks associated with being too concentrated in one market.

Bond Allocation:

Bonds play a crucial role in stabilizing your portfolio, especially during times of stock market volatility. When choosing bonds, you may opt to focus on local options to avoid the additional risks associated with foreign currencies. Government bonds are typically considered less risky and can provide a steady income, making them a suitable choice for investors looking to keep things simple.

A basic example of a diversified portfolio might include a mix of both stocks and bonds, split between local and international assets to help manage risk and enhance potential returns. 

Here’s an example of a basic investment portfolio:

30% Australian Stocks 

30% International Stocks 

40% Australian Bonds 

Adding complexity: Taking a More Diversified Approach

If you're ready to adopt a more hands-on strategy, further diversification within your portfolio can provide additional opportunities for growth and risk management.

For example, you might consider including small-cap stocks, which have historically shown strong performance in certain markets, though they can also be more volatile. The performance of small-cap stocks can vary significantly depending on the region. In some markets, such as the U.S., they have often outperformed large-cap stocks over time. However, in other markets, like Australia, small caps have underperformed due to the presence of many high-risk, unprofitable companies.

You might also explore adding value stocks, which research suggests have the potential to outperform growth stocks over the long term. Additionally, including assets like Real Estate Investment Trusts (REITs) can offer exposure to the property market, potentially reducing overall portfolio risk due to their historically lower correlation with other asset classes.

A more diversified portfolio could involve a blend of different types of stocks—both large-cap and small-cap—across various sectors and geographic regions, alongside a stable base of bonds to maintain balance. This way, you are not only positioned to capture growth opportunities in different markets but also manage the inherent risks through a broader asset mix.

Here’s an example of a more diversified portfolio:

14% ASX Large Cap Stocks

14% ASX Small Cap Stocks 

2% Australian Property 

14% International Large Cap Stocks 

7% International Small Cap Stocks 

7% International Value Stocks 

2% International Property 

40% Australian Bonds 

Asset Selection: Low Cost Index Funds Vs Managed ETF's

When choosing investments, consider the benefits of low-cost index funds versus managed funds. Managed funds offer professional oversight and potential market outperformance but come with higher fees. Low-cost index funds, which passively track market indices like the ASX 200 or S&P 500, have lower fees and provide broad diversification. Your choice depends on your financial goals, risk tolerance, and preference for active or passive management.

Core-Satellite Approach: Balancing Simplicity and Activity

If you're looking to take a more active role in your investment strategy, consider the Core-Satellite Approach. This strategy involves dedicating a significant portion of your portfolio—approximately 80%—to low-cost, passive investments such as ETFs, while actively managing the remaining 20%. This balanced method ensures the stability of your core investments while allowing you the flexibility to engage in specific investment opportunities, whether that means selecting individual stocks, exploring niche sectors, or investing in actively managed funds.

Rebalancing: Keeping Your Portfolio on Track

Regardless of the approach you select, regular rebalancing is crucial for maintaining your desired risk level and optimizing returns. Rebalancing entails selling assets that have performed well and reinvesting in those that have underperformed to keep your target allocation intact. Aim to rebalance annually or biennially, but be mindful of potential tax implications, such as capital gains tax, when selling assets.

Dollar-Cost Averaging: Investing Gradually

If the prospect of investing a lump sum all at once feels overwhelming, consider Dollar-Cost Averaging. This strategy involves consistently investing a fixed amount at regular intervals, irrespective of market conditions. It helps mitigate the risks associated with market timing and ensures your investment approach remains disciplined and free from emotional biases.

The Bottom Line

There’s no flawless asset allocation that ensures high returns during prosperous times and shields you from losses during downturns. The objective is to construct a portfolio resilient enough to weather all market conditions. At Transpire Wealth, we specialize in designing portfolios as unique as our clients—meticulously tailored to your goals, risk tolerance, and time horizon.

Investing transcends mere numbers; it’s about discovering a strategy that aligns with your life and maintaining that course. If you’re uncertain about where to begin or need assistance in refining your strategy, our dedicated team is here to support you every step of the way.

Stay tuned for our next post, where we'll delve into the pros and cons of 'all-weather' portfolios!

Ready to take control of your financial future? Contact us today at Transpire Wealth and start building your ideal investment portfolio.

General Advice Disclosure

The information provided on and made available through this website is general in nature and has been prepared without taking into account your objectives, financial situation or needs – it may not be appropriate to your situation. Before acting on this information, you should consider it’s appropriateness to your personal situation. The information provided is not intended as, nor is it a substitute for, personal or institutional financial services advice. 

We recommend that you obtain your own independent professional advice before making any decision in relation to your particular requirements or circumstances. Before acquiring any financial product, you should obtain the relevant Product Disclosure Statement (PDS) for any product mentioned and consider its contents before making any decision. Past performance of any product discussed on this website is not indicative of future performance. We do not warrant that any future forecasts are guaranteed to occur.