In the world of investing, there is two schools of thought – pick your stocks and build your portfolio, or invest in a built in portfolio (i.e. mutual funds, index funds, etc.). This article would discuss when, how, and the what surrounding the above two cases.
Build your own Portfolio
- This option is for someone who is an experienced investor, researches their holding(s) before buying a given security.
- This option works best for someone who like mentioned above is an experienced investor, has enough capital to deploy and buy at least 7-10 stocks, and knows exactly how to prioritize one purchase from another. It is essentially this I want to talk about – the portfolio building process.
How to build a portfolio?
- Know the direction of the economy – this is essential, as you do not want to be purchasing a “good” company which is in odds with the economic direction. Why? Simply because it would take longer to profitable and while it may be a good company, not buying it on a right time, might make you reconsider your decision by selling it for a cheaper value.
- Allocate Capital – A portfolio manager’s job is to allocate capital. The best way to go on doing this is by having a weight structure in mind (say 5% for 20 stocks in your portfolio). Then, initiate your positions in those companies at a suitable time (when the stock drops for an unwarranted reason).
- Build Slowly – After initiating positions in the securities of interest, build slowly! Buy the dips, or when the market has suffered a bigger than usual declines. The reason why you initiate the position first, is so that you can keep an eye on the fluctuations and double down later.
- Usually, I add the stocks of interest on Google Finance, and monitor them. As I find them dropping due to Mr. Market acting irrational, I simply buy it. Even then, I would continue to add more if a given security fits within my investment purpose.
- Hedge – This is one of the most important lessons I learnt when I traded options. Hedging is one of the most important aspect of a portfolio. It simply allows me to sleep better at night, without pressing the panic button. However, you must allocate an appropriate weightage, or it might still give you sleepless nights.
- Forget theory – As someone who has studied Finance, I can safely say, my education in Finance did not prepare me for success in investing in stock market(s).
- Always keep cash – You do not have to essentially keep cash in your brokerage account, but always have cash available to your disposal should there be any opportunity. What I mean by this is, you cannot be investing if you are having a tough time meeting your fixed monthly expenses. It simply does not work.
- Know your investment criteria – Know what kind of person you are. The type of your personality will affect your success or failure with your investments.
- Can you stomach a potential loss (it is not realized yet), knowing you have complete faith in your research abilities and your stock pick(s)?
- Are you a dividend investor or growth investor?
- How soon are you going to be needing this money? Ideally you would want to leave the money into your investment accounts untouched for 10 years.
- Your age profile – Do you have 40 years before you will retire? If so, invest in quality growth companies, and let time work the compounding magic for you.
- Do not listen to daily news, they are noise – Trusting your research more is important. It does not mean, you turn a blind eye to an alternative hypothesis, but you should evaluate all the reasons that made you buy the stock before selling it. Again, this is why it is important to have set a reasonable expectation based on your initial hypothesis before you buy a stock.
Beauty about ETFs and or low cost Mutual Funds
If you’re starting out, ETFs, and low cost Mutual Funds provide a great option for an early investor. Not only do you save time on building the portfolio, but you can get it up to a sizeable balance before venturing into buying stocks.
A word of caution, make sure you know what your ETF/Mutual Fund is offering you. You must know the full 100% of its portfolio breakdown, or else you might be on your way to lose money just like in 2007-8 crash; where the portfolio was filled up with junk investments.
Also, making sure their management is sound by looking at their management fees, and their returns history is a must. It tells you how certain your investments would be in times of uncertainty. The only drawback of buying ETFs, and mutual funds is you lose your freedom to select your investments.
Some examples of cheaper ETFs providers include BlackRock, and Vanguard.
When to Buy?
After investing for about 5-7 years, I have learnt the importance of staying disciplined when buying a stock. The question then is, how do I make the purchases, what time specifically? The following is what I follow:
- “Buy when there’s blood on the streets,” a phrase coined by Nathan Rothschild serves as an apt reminder to me when should I buy – when the outlook is all doom and gloom.
- ”Be Fearful When Others are Greedy,” from Warren Buffett again underlines the above and sets the tone for when to sell as well.
- Essentially, you are going against the crowd. The payoff potential is huge, as you’re not following the herd. Remember the sheep get slaughtered! When the doom and gloom outlook is mixed with your in depth investment research, it can be really profitable.
- You don’t make money by listening to your friend’s hot tip, or following someone into an investment which that person is gloating about. If you do make a mistake, it is you. You’ll learn from it. Most importantly, you want to be learning from others mistakes.
- I like both – investing in individual stocks and mutual funds. In times of uncertainty (i.e. when the market has dropped tremendously), I favor investing with mutual funds. Why? Simply because the losses would not be as steep as holding an individual security, as it is average holdings.
- Considering how I like my freedom with my investments, I like investing in stocks of my own choice. Researching mixed with the patience of holding on to your investments in tough times is most gratifying when you start seeing the tide turn over.
If you want to know more about how I make my purchases, check these articles – part I, and part II. As to how I conduct my research, check out this article here. As for the books that I recommend reading, they can be found here.
Next, I will cover the most important aspect of investments in stock markets – when do you sell.
Tell me about your tips and tricks that works for you in achieving balance while building your portfolio. How do you go on about it…?