The Step by Step Portfolio Planning Process

By
Richard Best
Richard Best
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Richard has more than 30 years of experience in the financial services industry as an advisor, managing director, and director of training and marketing, specializing in Finra exams, investing, and retirement planning. He has served as an editor or expert contributor for more than a dozen books, including Webvisor, Wealth Exposed, 5 Steps for Selecting the Best Financial Advisor, and The Retirement Bible. His personal finance column appears on the sites of more than 100 regional and community banks.
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Updated October 29, 2022
Reviewed by Pamela Rodriguez
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Vikki Velasquez
Vikkie Velasquez
Fact checked by Vikki Velasquez
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Vikki Velasquez is a researcher and writer who has managed, coordinated, and directed various community and nonprofit organizations. She has conducted in-depth research on social and economic issues and has also revised and edited educational materials for the Greater Richmond area.
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There are few things more important and more daunting than creating a long-term investment strategy that can enable an individual to invest with confidence and with clarity about their future. Constructing an investment portfolio requires a deliberate and precise portfolio-planning process that follows five essential steps.

Key Takeaways

  • In order to plan for the future, first take a cold, hard look at the present, sifting through all current assets, investments, and any debt; then, define your financial goals for the short- and long-term.
  • Figure out how much risk and volatility you're willing to take on, and what returns you want to generate; with a risk-return profile established, benchmarks can be set in place to track portfolio performance.
  • With a risk-return profile in place, next create an asset allocation strategy that is both diversified and structured for maximum returns; adjust the strategy to account for big life changes, like buying a home or retiring.
  • Choose whether you want active management, which might include professionally managed mutual funds, or passive management, which might include ETFs that track specific indexes.
  • Once a portfolio is in place, it's important to monitor the investment and ideally reassess goals annually, making changes as needed.

Step 1: Assess the Current Situation

Planning for the future requires having a clear understanding of an investor’s current situation in relation to where they want to be. That requires a thorough assessment of current assets, liabilities, cash flow, and investments in light of the investor's most important goals. Goals need to be clearly defined and quantified so that the assessment can identify any gaps between the current investment strategy and the stated goals. This step needs to include a frank discussion about the investor’s values, beliefs, and priorities, all of which set the course for developing an investment strategy.

Portfolio planning is not a one-and-done deal—it requires ongoing assessments and adjustments as you go through different stages of life.

Step 2: Establish Investment Objectives

Establishing investment objectives centers on identifying the investor’s risk-return profile. Determining how much risk an investor is willing and able to assume, and how much volatility the investor can withstand, is key to formulating a portfolio strategy that can deliver the required returns with an acceptable level of risk. Once an acceptable risk-return profile is developed, benchmarks can be established for tracking the portfolio’s performance. Tracking the portfolio’s performance against benchmarks allows smaller adjustments to be made along the way.

Step 3: Determine Asset Allocation

Using the risk-return profile, an investor can develop an asset allocation strategy. Selecting from various asset classes and investment options, the investor can allocate assets in a way that achieves optimum diversification while targeting the expected returns. The investor can also assign percentages to various asset classes, including stocks, bonds, cash, and alternative investments, based on an acceptable range of volatility for the portfolio. The asset allocation strategy is based on a snapshot of the investor’s current situation and goals and is usually adjusted as life changes occur. For example, the closer an investor gets to their retirement target date, the more the allocation may change to reflect less tolerance for volatility and risk.

Your risk-reward profile will change over the years, tilting further away from risk the closer you get to retirement.

Step 4: Select Investment Options

Individual investments are selected based on the parameters of the asset allocation strategy. The specific investment type selected depends in large part on the investor’s preference for active or passive management. An actively managed portfolio might include individual stocks and bonds if there are sufficient assets to achieve optimum diversification, which is typically over $1 million in assets. Smaller portfolios can achieve the proper diversification through professionally managed funds, such as mutual funds or exchange-traded funds. An investor might construct a passively managed portfolio with index funds selected from the various asset classes and economic sectors.

Step 5: Monitor, Measure, and Rebalance

After implementing a portfolio plan, the management process begins. This includes monitoring the investments and measuring the portfolio’s performance relative to the benchmarks. It is necessary to report investment performance at regular intervals, typically quarterly, and to review the portfolio plan annually. Once a year, the investor’s situation and goals get a review to determine if there have been any significant changes. The portfolio review then determines if the allocation is still on target to track the investor’s risk-reward profile. If it is not, then the portfolio can be rebalanced, selling investments that have reached their targets, and buying investments that offer greater upside potential.

When investing for lifelong goals, the portfolio planning process never stops. As investors move through their life stages, changes may occur, such as job changes, births, divorce, deaths, or shrinking time horizons, which may require adjustments to their goals, risk-reward profiles or asset allocations. As changes occur, or as market or economic conditions dictate, the portfolio planning process begins anew, following each of the five steps to ensure that the right investment strategy is in place.

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