A portfolio is a collection of investments designed to work together. Understanding how different components interact is fundamental to investment education.
There are many approaches to portfolio construction. This lesson explores widely-taught concepts, though individual circumstances always vary.
Asset Allocation
Asset allocation refers to how investments are divided between different asset classes like stocks, bonds, and alternatives. Academic research suggests it's a significant factor in long-term portfolio behaviour.
Explore how age and risk preference affect a common allocation formula:
Age: 35
Risk preference: 5/10
Stocks
65%
Bonds
35%
Based on common “age-based” formula. Educational illustration only — actual allocations depend on many personal factors.
Common portfolio archetypes
Illustrative examples, not recommendations. Historical returns vary.
Diversification
Diversification — spreading investments across different assets — is a widely-taught principle for managing risk. When investments move independently of each other, poor performance in one area may be offset by performance in another.
Across asset classes
Stocks, bonds, real estate, commodities
Geographic
UK, US, Europe, Emerging Markets
Sectors
Technology, healthcare, financials, energy
Company size
Large cap, mid cap, small cap
Time
Regular investing (pound-cost averaging)
Diversification cannot eliminate all risk. Correlations can increase during crises. Over-diversification adds complexity without proportional benefit.
Time Horizon
How long until you need the money is frequently cited as a key factor in portfolio construction. Longer time horizons have historically allowed investors to ride out market volatility.
Long horizon (20+ years)
Historically associated with higher equity allocations, a focus on growth, and time to recover from volatility.
Medium horizon (5–20 years)
Often associated with mixed allocations, balance of growth and stability, and gradual risk adjustment.
Short horizon (<5 years)
Often associated with lower volatility focus, capital preservation priority, and less time to recover from losses.
Traditional rules like “100 minus your age in bonds” are educational starting points, not personalised advice. Individual factors matter significantly.
Rebalancing
Rebalancing is the process of returning a portfolio to its target allocation. As different investments perform differently, allocations drift over time. If stocks outperform bonds, a 60/40 portfolio might drift to 70/30.
Rebalancing maintains your intended risk level and enforces a “buy low, sell high” discipline. Consider transaction costs and tax implications — frequent trading may not always be beneficial.
Practical Steps
These are commonly discussed steps in investment education. Individual circumstances vary — consider consulting a qualified financial advisor for personalised guidance.
Define your goals
What are you investing for? When do you need the money?
Assess your situation
Consider time horizon, income stability, existing savings.
Choose an allocation
Based on goals, time horizon, and risk preference.
Select investments
Individual securities, funds, or a mix.
Implement and monitor
Make purchases and review periodically.
Ignoring costs.
Fees compound over time. Lower-cost options keep more money invested.
Chasing past performance.
What performed well recently may not continue. Past performance does not indicate future results.
Emotional reactions.
Buying high during euphoria and selling low during panic is a common pattern.
Neglecting diversification.
Concentrating in a few investments increases risk. Spreading is a fundamental principle.
Ignoring time horizon.
Short-term money may need different treatment than long-term investments.