When you first begin to invest, and probably even before, you will constantly hear the word “portfolio.” This is a word that refers to a collection of investments or assets. So, what exactly, does that mean?
Artists use the word to describe a collection of their art. Writers use the word to describe a collection of their writing. Investors use it to describe a collection of their investments.
In the investing world, a portfolio can be as broad or as narrow as there are different types of investments. For instance, someone who only has a few different investments, such as a 401K, 100 shares of stock and a few bonds, may use the word to encompass all of their investments. However, someone with a lot of different investments like 20,000 shares of stock, 54 rental homes, etc., might use it just for one category, such as a stock portfolio.
The media often draws attention to retirement portfolios, which encompass the assets you own that will continue to sustain your way of life once you’ve retired. These assets are often from interest, rental income, and dividends.
As the boss of your life, it is your responsibility to build a portfolio that works for you, that you understand, that minimizes risk, and that can be administered at a reasonably low cost. Normally, people begin their portfolios when they sign up for their first 401k through their job. Others will open an account through Vanguard or Betterment, which deal in mutual funds.
An even smaller number of beginning investors opt to open a regular brokerage account or invest through dividend reinvestment plans (DRIPs). Both of these options are fully taxable.
How Portfolios Earn Money
There are typically 5 ways that portfolios can make money:
Dividends: When you own an asset such as a stock, your share of the profits will sometimes be paid out as dividends.
Interest – This is income you receive when you lend money. Just like interest you pay on a bank loan, you can collect interest as a payment for doing the lending.
Rental Income – This is money that is paid to you by a tenant while they use or occupy your property. Common types of rental income can come from rental homes, storage units, cars, etc.
Royalties and Licensing Rights – If you have creative or intellectual property, you can license the rights and receive income. For instance, merchandisers pay Disney for the right to use certain characters on items they are selling. Disney gets to just sit back and enjoy the flow of income.
Capital Gains – When you sell an asset for more than you paid for it, the difference is called a capital gain.
How to Create Your Own Portfolio
There are guides all through the internet that take you step by step through the process of building your first portfolio. These guides encourage you to consider how your investments will affect each part of your life. For example, if you’re 20 years old and want to travel the world, having all of your assets in retirement accounts that you can’t touch for 45 more years won’t help you. Additionally, these guides also spell out the dangers of investing before more pressing needs are met, such as insurance and emergency funds. If all of your money is tied up in a 5 year CD and you experience an emergency, you’ll end up having to go into debt by taking out a loan or face large penalties for withdrawing money from your account early. One emergency can destroy decades of investment strategy.