You can tell a lot about someone by observing their finances. All you have to do is take a peek at their checkbook log, credit card statements or their investment portfolio. There's enough information there to draw several possible conclusions about many aspects of their lives. The contents of your portfolio can often provide a glimpse into your age and philosophies. (For more, see Measure Your Portfolio's Performance.)
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A portfolio is sometimes a good indicator of an investor's age since younger people usually assume more risk than those who are retired or approaching retirement. Young people are counting more on long-term capital appreciation than on a steady income stream, so their portfolio would be more concentrated in growth stocks and mutual funds that yield higher potential returns.
People of middle-age tend to transition from an emphasis on growth to a more balanced allocation that could include growth stocks, stocks paying dividends, bonds, index funds, real estate and foreign equities. This approach protects some of your capital while still maintaining the opportunity for future growth. At the same time, income will be generated that can be reinvested, if you don't need it for living expenses.
Your portfolio's percentage allocation of investments will provide an excellent gauge of your risk tolerance. If your portfolio is full of stocks with a beta greater than the market average of 1.0, then you are assuming greater risk and greater potential for higher returns and losses. Examples of stocks with high betas are emerging technology, recent IPOs, and biotechnology. Currencies would be considered high risk, except to those who are experienced in trading them.
Medium risk investments include blue-chip stocks, diversified mutual funds, corporate bonds, precious metals and stocks paying regular dividends. Up until the collapse of the housing bubble, real estate would have been considered a low-risk investment. Now that prices have dropped substantially, new buyers are assuming moderate risk.
Your risk tolerance is low if your investments are focused in savings accounts, money markets, government bonds, certificates of deposit, and mutual funds that concentrate on capital preservation.
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Investor Vs. Trader
A primary difference between investors and traders is that investors are usually focused on the long-term, where traders are focused on the short-term. An investor will buy a stock that has prospects for capital appreciation over a period of several months or years. It's not unusual for some people to hold stocks for decades and pass them on to their heirs.
Traders fall into two general categories: day traders and swing traders. A pure day trader may buy and sell the same stock several times in the same day, with the objective of holding 100% cash at the close of trading. Many day traders have a list of stocks that they track closely, allowing them to acquire an understanding of how they move and react to news events. Swing traders typically buy stock and sell it within a matter of a few days or weeks.
The investor's portfolio will likely contain a list of investments that appear on their statement every month and few - if any - trades. The trader's statement will show lots of buys and sells, but very few closing positions. (To learn more, check out Mastering Short-Term Trading.)
Some investors prefer certain categories of investments that aren't necessarily related to risk or other factors. For example, some people prefer to only buy mutual funds because they want professional management of their money. Others buy individual stocks and bonds because they want direct control over their money and prefer not to pay management fees.
Some investors like to specialize because they believe this gives them an advantage over those that are not as familiar with their area of expertise. For example, some investors focus strictly on real estate because they understand their local market. Others prefer to stick to index funds as a way of spreading their money while tracking financial performance to specific indexes.
The Bottom Line
Your portfolio provides a view into how you approach investing for your future, as well as what you have done in the past. If your list of stocks includes some that are currently losing positions, that's an indication that you are hoping they will come back at some point. Take a close look and see if you might be better off selling them and reallocating your capital into better investments. Investing is a learning process and it pays to learn from your past mistakes and experiences. (To learn more, see our Investing 101 Special Feature.)
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