A step-by-step guide to building your portfolio

“WHEN PEOPLE ASK ME, ‘What’s the best time to start investing?’ my answer is ‘Right now,’” says Marci McGregor, head of Portfolio Strategy for the Chief Investment Office (CIO), Merrill and Bank of America Private Bank. “If you’ve held off because investing seems confusing and you don’t know where to begin, just take it one step at a time, starting with identifying what you’re investing for,” she suggests.

Below, she outlines seven key steps to building a portfolio tailored to your specific needs, now and in the long term. Whether you’re just starting out or want to revisit your current investing approach, these steps can help get — and keep — you on the right track.

Step 1. Ask yourself: What am I trying to achieve?

“Your financial goals are the ‘why’ of investing,” McGregor says. Make a list of your long-term objectives, such as paying for retirement, a home or education. Next, think about:

• Your time horizon: When will you need the money for those goals?
• Your risk tolerance: All investing involves some risk. How much feels right for you, based on your emotions and financial situation?
• Your cash, or liquidity, needs: Do you anticipate needing to draw on investments to meet regular expenses any time soon?

The investing basics — in 5 minutes

Step 2. Decide on your personal investing formula

“Now you’re ready to move from why you invest to how — figuring out the right asset allocation, or mix of stocks, bonds, cash and other types of investments to help you pursue your goals,” McGregor says. Think of it as your personal formula for investing. In investing, one size doesn’t fit all, and your preferred asset allocation will likely differ in many ways from other’s. “Research shows that asset allocation is a primary driver of portfolio performance,” McGregor adds.¹

Watch this short video for help determining your asset allocation.

Your formula will depend largely on your risk tolerance and how much time you have to invest for your goals. With many years to invest, your portfolio might include more stocks, which carry greater short-term risk but over time tend to produce higher returns. If your time horizon is short or you’re uncomfortable with risk, bonds might play a greater role. An advisor can help determine the asset allocation that’s appropriate for you.

Whether your personal formula favors stocks or bonds, make sure it includes some of each so that your portfolio is diversified. Because stocks and bonds tend to respond differently to market conditions, diversification offers the best chance for long-term growth and protection, McGregor says. Diversify within those asset classes as well — for instance, including exposure to different sectors of the stock market or types of bonds — and keep in mind that having some cash in your portfolio can help you meet routine or unexpected expenses without having to sell investments.

Check out the video below for more on the benefits of being diversified.

Step 3. Ready, set, invest …

Now that your personal formula, or desired asset allocation, is set, and you understand the value of being diversified, you’re ready to build your portfolio. Start by researching the universe of investing possibilities, including mutual funds and exchange-traded funds, in addition to individual stocks and bonds, online or through an advisor. “If you have an advisor, you can work together, using the CIO’s due diligence process, to identify potential investments that are complementary to your objectives,” McGregor says. An investment approach called dollar cost averaging — investing a set amount of money at regular intervals — can help you lower the average cost per share of your trades.² 

Get more details on your investing options in the video below.

Step 4. Round out your portfolio

With your core portfolio shaping up, you might want to explore additional investments that align with your values or help you achieve certain goals. “You could, for instance, think about investing in renewable energy to help fight climate change and potentially benefit from the transition away from fossil fuels,” McGregor says, or pursue additional growth through funds that are actively managed by professional investment managers who seek to outperform certain indexes or benchmarks.³ For qualified investors, alternative investments such as real estate or private equity could help you pursue growth while helping to reduce risk. An advisor can help you determine if any of these approaches might be suitable for your situation.

Step 5. Manage tax efficiency and transaction costs

Considering tax implications and transaction costs could help you keep more of your returns, McGregor suggests. Weigh the benefits of traditional IRAs and 401(k)s (where you invest pretax dollars and defer taxes until you take distributions in retirement) vs. Roth IRAs and Roth 401(k)s (where you invest after-tax dollars but pay no taxes when you withdraw money in retirement). For the taxable portions of your portfolio, you might consider municipal bonds offering Federal (and, in some cases, state) tax-free income — especially if you are in a higher tax bracket. Meanwhile, “sticking to a long-term strategy rather than trying to ‘time’ markets by rapidly buying and selling can help keep transaction costs down while reducing risk,” she adds.

Step 6. Review your portfolio regularly

No portfolio is a “set it and forget it” proposition. As your life and financial markets evolve, your well-conceived asset allocation model can drift off course. “At least once a year, review your goals, cash needs, time horizon, risk tolerance and portfolio performance,” McGregor says. In order to stay aligned with your preferred asset allocation, you may need to periodically rebalance your portfolio by selling some assets that have grown in value and buying others that have lagged. And if your priorities and goals change, you may need to adjust your asset allocation.

Step 7. Look for buying opportunities —  and stay invested

Once you’ve developed the investing habit, stay with it. “Volatility is a normal part of investing,” McGregor says. Investors without clear strategies might be tempted to sell during a market decline and miss out on substantial gains when markets rebound. “Missing just the 10 best market days in the 2010s would have left an investor with returns of only 95% on the decade, versus 190% for those who stayed invested,” she adds.⁴ Instead of selling, you might use those periods of weakness as an attractive buying opportunity, to add strategically to your portfolio. Says McGregor, “Time itself is one of your best assets.”

For more information on building your portfolio, read the Chief Investment Office report, “Steer the course of your financial future: A guide for long-term investors.”