Constructing an Investment Portfolio - Essay Sample

Introduction

During the creation of an investment portfolio, several factors are essential to consider. For instance, age has to be evaluated while the debt to equity ratio must also be considered. Managers need to review the assets, income, parental, marital, and risk status of an individual. The ability of an individual to tolerate threats may also be determined in the process of determining the most profitable investment portfolio. Other factors may include diversification, guidance, and expenses. Nevertheless, all these factors may be summed up in four main categories; determining the return on investment, determining the risks involved, analyzing the level of diversification, and evaluating the effect of the lottery. Therefore, the purpose of this paper is to assess the various factors affecting the construction of an investment portfolio in the four categories mentioned above.

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Part 1

Determining the Return on Investment

An essential part of an investment portfolio is the return on investment (ROI). It is important that the value of every dollar is determined to ensure that even the expected returns on the invested amount are estimated (Fabozzi & Pachamanova, 2016). ROI helps the inappropriate management of funds. It is determined by the difference between gains and costs, which is divided by costs. As a ratio, it is determined as;

ROI= (Gains- Costs)/Cost.

The ROI is dependent on the securities that you, as an investor, would choose to invest in. A higher ROI implies that the potential risks to sabotaging your investing plan are also high.

Measurement of Risks

Reducing risks that are likely to affect your business is an essential part of business growth. The goals of a business portfolio may differ from one investor to another. If your goal is to maintain your current assets, it implies that you look forward to securing and safe investments. Therefore, you have to reduce the risks to your investments by all means (Fabozzi & Pachamanova, 2016). One of the significant risks to a business is the inflation rates that appear unexpectedly. However, there are two main ways of reducing such risks. The first way is to select your securities appropriately. A government bond may not give you the chance to flex around, yet the risks involved are very minimal. On the contrary, an investment in penny stock my give you the best process yet. The changes appear so often as the stock is susceptible to inflation rates.

Diversification

Investors will need a diversified portfolio to flex between peak and off-peak pricing. However, over-diversification can be hazardous to your portfolio. To balance your portfolio, it is essential to consider that the gold and silver stocks and those that involve technology. Such stores can be flexible and are necessary for dealing with the middle-level effect.

The Lottery Effect

It entails the high risk/high returns speculation. Some investors would have the mindset that the higher the risks, the higher their investment (Henriksson et al., 2019). However, there is a higher possibility that such deals land the investor in debts that force him to sell assets at a throw-away price. Hence, the lottery effect has to be dealt with as soon as possible.

Importance of a diversified portfolio

Diversifying a portfolio allows an investor to balance between peak prices and off-peak prices. It is also vital to have a diverse portfolio to help an investor or manager reduce the risks. For instance, a portfolio with only one type of assets implies that an individual will be forced to sell some of the assets at a lower cost to balance the debt to equity ratio (Henriksson et al., 2019). Besides mitigating individual risks, it is essential to diversify the stocks that are affected by market changes across an economy.

Part Two

Efficient Market Hypothesis

The Efficient Market Hypothesis is a theory that states a market can be so efficient that at any given time, its prices reflect the stock value (Fabozzi & Pachamanova, 2016). Hence there is no over-valuing or under-valuing of stock on such occasions. On the contrary, diversification requires that an investor creates a middle effect where peak and off-peak prices do not sabotage the stock. Therefore, the balance in between shows that EMK fits inappropriately with the mantra of diversification (Henriksson et al., 2019).

Studying Stock Fundamentals

The EMH failed in addressing worldwide asset owners who use the skill to maneuver in their investments. Hence, the theory remains unverified on whether it is true or false. Therefore, investors still need a fundamental analysis to aid in the choice of appropriate stocks. Fundamental analysis is essential in predicting the future movement of stock prices (Henriksson et al., 2019). Investors also get the opportunity to determine the fair value of the stock by reviewing the appropriateness of the expenses (low or high). A company may also use fundamental analysis to decide on its competitive advantage against its rivals. Companies also use such analyses to review their financial performance. Reviewing the return on investment of an asset helps determine the growth level in your company. Therefore, fundamental stock analysis is a process that uses economic and financial information to predict the trends in stock prices for the future.

References

Fabozzi, F. J., & Pachamanova, D. A. (2016). Portfolio construction and analytics. John Wiley & Sons. https://books.google.com/books?hl=en&lr=&id=loUgCwAAQBAJ&oi=fnd&pg=PR19&dq=Constructing+an+Investment+Portfolio&ots=EBOfqqhBFX&sig=PPzDFeoR_hDDz7bNq9li0_iXqVU

Henriksson, R., Livnat, J., Pfeifer, P., & Stumpp, M. (2019). Integrating ESG in portfolio construction. The Journal of Portfolio Management, 45(4), 67-81. https://jpm.pm-research.com/content/45/4/67/tab-pdf-trialist