Let's Build a Portfolio

Welcome back to our series of articles where we embark on a journey towards financial well-being. If you haven't had a chance to read the previous articles, you can find them all?here, designed to be read in order and offering a 5 to 7-minute read per article. Together, they form a comprehensive guide that aims to empower you on your financial journey.

The last article talked about how to use your paycheck to build an investment portfolio for long-term goals using the power of the Dollar-average strategy. However, it was only for illustration purposes and didn't take into account your individual risk appetite or tolerance. The question here is how one can improve the portfolio risk without compromising returns or how to construct a portfolio from your paycheck that you can be comfortable with.

The first step before investing is to determine your risk appetite. You need to ask yourself honestly, 'Who am I?' To do this, you have several options available. You can consult an investment advisor who can help you assess your risk tolerance and provide guidance. Alternatively, you can try using some available tools to gain insights into how these investment strategies usually work.

What is Risk Profiling?

Defining your risk profile is fundamental to successful investing. Your risk profile reflects your willingness and ability to tolerate fluctuations in the value of your investments. Here's what you need to know:

Definition of Risk Profile: A risk profile encompasses your personal preferences, financial goals, time horizon, and attitude towards risk. It helps determine the appropriate level of risk you should take on in your investment portfolio.

Different Risk Profiles: Risk profiles are usually categorized into conservative, moderate, and aggressive. Conservative investors prioritize capital preservation and are averse to significant fluctuations. Moderate investors seek a balance between growth and stability, while aggressive investors are willing to take on higher levels of risk in pursuit of higher returns.

Assessing Your Risk Tolerance: Understanding your risk tolerance involves evaluating your financial situation, investment knowledge, and emotional response to market volatility. A thorough self-assessment can guide you in determining the risk profile that aligns with your comfort level.

Below is a risk assessment tool you can use for illustration purposes.

https://www.fidelity.co.uk/funds/risk-calculator-tool/

Asset Allocation Strategies

Once you have determined your risk profile, it's time to consider asset allocation strategies that align with your investment goals and risk tolerance. Asset allocation refers to the distribution of your portfolio across different asset classes, such as stocks, bonds, cash, and other investment instruments. Here's what you should know:

Importance of Asset Allocation: Asset allocation is a critical factor in portfolio construction as it has a significant impact on your portfolio's performance and risk level. Proper asset allocation can help diversify your investments and mitigate potential losses.

Understanding Asset Classes: Each asset class carries its own risk and return characteristics. Stocks offer potential for higher returns but come with greater volatility. Bonds provide income and stability but may offer lower long-term growth. Cash provides stability but generally has minimal growth potential.

• Allocation for Conservative Investors: Conservative investors, focused on capital preservation, may allocate a larger portion of their portfolio to low-risk assets such as bonds or cash. This approach aims to provide stability and minimize potential losses during market downturns.

• Allocation for Moderate Investors: Moderate investors typically seek a balanced approach, allocating their portfolio across a mix of stocks and bonds. This allows for potential growth while still providing a cushion against market volatility.

• Allocation for Aggressive Investors: Aggressive investors, seeking higher growth potential, may allocate a larger portion of their portfolio to stocks. This approach entails a higher level of risk but also offers the potential for greater returns over the long term.

To visualize it, here below is how money or portfolio is typically allocated for each risk profile.

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So, What instruments work for this strategy?

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Here are some examples below that we can use as investment instruments to allocate small amounts.

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Examples of Conventional ETFs to construct a portfolio with small amounts:

Bonds: iShares Core U.S. Aggregate Bond ETF (AGG) – Price $97.97

Stocks: Vanguard Total Stock Market ETF (VTI) – Last price $213.93

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Examples of Sharia-Compliant ETFs to construct a portfolio with small amount:

SUKUK: SP Funds Dow Jones Global Sukuk ETF (SPSK) – Last Price: $17.81

Stocks: Wahed FTSE USA Shariah ETF (HLAL) – Last price: $41.32

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Monitoring and Rebalancing Your Portfolio

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Once you have constructed your portfolio of ETFs or mutual funds based on your risk profile and investment preferences, it is crucial to regularly monitor and rebalance your holdings. Here are some key considerations:

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·??????Periodic Review: Conduct periodic reviews of your portfolio, typically on a quarterly or annual basis. Evaluate the performance of your investments, assess market conditions, and determine if any adjustments are necessary.

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·??????Rebalancing: Rebalancing involves adjusting your portfolio's asset allocation to maintain your desired risk profile. If certain investments have performed exceptionally well or poorly, it may be necessary to reallocate funds among different asset classes or investment options.

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·??????Risk Assessment: Regularly reassess your risk tolerance and investment goals. As your financial situation or objectives change, you may need to make adjustments to your portfolio to align with your evolving needs.

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Remember that constructing and managing a portfolio is an ongoing process. Regular monitoring and rebalancing help ensure your investments stay on track and reflect your risk profile and investment preferences over time.

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By following these steps, you can construct a well-diversified portfolio of ETFs or mutual funds that aligns with your risk profile and investment goals, whether you prefer conventional or Sharia-compliant options. Remember to review your portfolio periodically and make adjustments as necessary to stay on track towards your financial objectives.

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Summary

Constructing a portfolio of ETFs or mutual funds based on your risk profile is a critical step towards achieving your investment objectives. Whether you prefer conventional investments, Sharia-compliant options, or a combination of both, there are key considerations to keep in mind:

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Know Your Risk Profile: Understand your risk tolerance and investment goals. This knowledge will guide your asset allocation decisions and help you determine the appropriate mix of investments.

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Diversification is Key: Aim for diversification across asset classes, sectors, and geographical regions. This helps spread risk and can enhance the potential for returns.

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Consider Cost Efficiency: Evaluate expense ratios and transaction costs associated with the ETFs or mutual funds you choose. Lower costs can contribute to higher net returns over the long term.

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In addition to the manual approach discussed in this article, it's worth noting that technology has made it easier than ever to automate the portfolio construction process. Through automated plans, you can set up recurring transfers from your checking account directly into your brokerage account, allowing you to consistently contribute to your investment portfolio.

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Furthermore, robo-advisors offer a streamlined and technology-driven solution for portfolio management. These platforms utilize algorithms and advanced analytics to construct and manage portfolios based on your risk profile and investment goals. Robo-advisors automate tasks such as asset allocation, rebalancing, and even tax optimization, providing a convenient and hands-off investment experience.

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By leveraging the power of technology and automation, you can simplify the process of portfolio construction and management. Automated plans and robo-advisors can help you stay disciplined, ensure regular contributions, and maintain a well-balanced portfolio over time.

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However, it's important to understand the features, fees, and limitations of these automated solutions. Consider factors such as the level of customization, customer support, and compatibility with your investment preferences before selecting an automated platform.

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Regardless of the approach you choose—whether it's manual portfolio construction, automated plans, or robo-advisors—regular portfolio review, monitoring, and adjustment remain crucial. Stay informed, track the performance of your investments, and make necessary changes to keep your portfolio aligned with your risk profile and investment goals.

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By combining the benefits of technology and informed decision-making, you can construct a well-diversified portfolio that suits your preferences, whether you are a conventional or Sharia-compliant investor.

Disclaimer: The information provided in this article is for general informational purposes only and should not be considered as investment advice. I do not guarantee the accuracy, completeness, or usefulness of any information presented in this article. It is important to do your own research and consult with a professional financial advisor before making any investment decisions.

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