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Previous:
How to Determine Your Level of Risk Tolerance

Next:
How to Research Stocks

How to Plan Your Stock Portfolio

Once you’ve determined your risk tolerance, your next step will be to plan out the type of stocks you want to hold in your investment portfolio. Stock portfolio planning rests on two pillars: asset allocation and diversification.

Asset Allocation

An asset is anything you own that has a cash value. In investing, there are a number of different types of assets, called asset classes. The major asset classes include:

Stocks
Bonds
Cash or cash equivalents (such as money market accounts or CDs)
Real estate
Precious metals and other commodities

Each asset class provides investors with different levels of risk and different levels of potential return. Asset allocation is the process of determining how much of each type of asset you should own, based on your risk tolerance.

How Much of Your Portfolio Should Be in Stocks?

The table below offers suggested asset allocations for investors with high, moderate, and low risk tolerances.

Risk Tolerance	Stocks	Bonds, Real Estate, Others	Cash
High	60–90%	0–30%	0–10%
Moderate	30–60%	0–30%	0–40%
Low	0–30%	0–30%	40–100%

For example, if you have $10,000 to invest and have a high risk tolerance, you could comfortably put $7,500 into stocks, $2,000 into bonds or real estate, and keep $500 in a prime money market account.

Diversification

Once you’ve determined how much of your available funds you plan to invest in stocks, you need to decide which types of stocks to buy. When planning your portfolio, you should always follow the principle of diversification, which states that any stock portfolio should include a mix of different types of stocks. Diversification is crucial because it limits risk without lessening the potential of future returns.

How Diversification Can Limit Risk

By owning various types of stocks, you protect your portfolio from the losses it might suffer as a result of company-specific or sector-specific risks. Even the most healthy and stable companies or sectors can fall victim to events beyond their control: lawsuits, accidents, terrorist attacks, government investigations of executives, and so on. So putting all your eggs in one basket is not a good idea.

At the same time, diversification can limit the growth of a portfolio, since some of the stocks in a diversified portfolio will likely be out of favor and decline in price while others thrive and increase in price. In the best-case scenario, the gains in share price of your thriving stocks will outweigh the losses you incur from also owning out-of-favor stocks.

Sample Diversified Portfolios

The mixture of stock types in your portfolio depend on your risk tolerance and goals.

If your risk tolerance is high, your diversified portfolio should have an emphasis on growth.
If your risk tolerance is low, your diversified portfolio should have an emphasis on income.

The types of stocks you buy can be based on one of the major classifications (market cap, growth vs. value, industry, domestic vs. international), or on various combinations of these classifications. The sample portfolios that follow use a combination of growth vs. value and domestic vs. international.