Ask any investment advisor, and he will tell you that the return achievable from equities is better in the long term than any other asset class. He’ll also tell you that to ensure your investments don’t suffer from a downturn in the stock market, you should consider diversifying into other asset classes. Then, to protect yourself from geographic economic shocks, you should widen your investments to encompass international stocks and bonds.
Suddenly, building an investment portfolio seems like very hard work. But it doesn’t have to be that way. Here we discuss how to build a stock portfolio that accomplishes all of the above.
Why do you want to invest?
The first thing to establish is the reason you want to invest. You should consider your aims now, and for the longer term. Predominantly, your overriding aim will be either to produce an income, or growth, or a combination of both.
The level of potential return is higher the more risk you are prepared to accept to your investment cash. Thinking about how a loss to your investment would affect you in the short term will help you figure out how much risk you can tolerate.
Once you understand your aims and your risk tolerance, then you will be able to begin to think about how to select the stocks for your portfolio.
Invest in different types of companies
Different types of companies will cater to your aims and risk profile.
For those investors looking to achieve capital growth, then growth stocks that plow profits into inward investment or acquiring other profitable companies offer longer term rewards. Speculative stocks, the shares of new and innovative companies, offer potentially very high returns, though the inherent risk is probably highest of all types of stock.
For those investors that want to profit from an economy that is growing strongly, then the shares of cyclical companies – those that do well when the economy does well – will be high on the list of stocks to buy.
If you want safer stocks that generally pay a high level of dividends, then perhaps either the shares of blue chip companies or defensive stocks will be the order of the day. Blue chips are the shares of the largest companies, whilst defensive stocks tend to outperform in a weaker economy. Growth in these may not be as high as the potential growth of speculative stocks, but they do offer some immunity from the shocks of economic or market turmoil.
Finally, there are the dividend stocks: shares of companies which have consistently paid high and growing dividends to shareholders.
Devise an Investment Strategy
Again, with a view to your long term aims and tolerance to risk you will need to consider how to select the stocks to invest in. By investing in different types of stocks, you will be able to match your risk profile and investment aims.
For example, an investor who has a very long time frame, looking for growth and can accept large short term losses may place a high percentage of his portfolio in speculative or growth stocks. At the other end of the scale, a far more cautious investor looking for income may invest mostly in the shares of blue chips and defensive, dividend stocks.
Having decided the mix of types of stock required to meet your current aims, you will need to use a consistent and logical method of selecting your stocks. This means choosing a valuation method that will compare similar stocks to each other to enable you to select those that offer the best value.
You also need to consider diversifying, not just in type of stock, but also across industries and geographies. By holding the stocks of companies in different industries, you portfolio will be exposed to winning sectors and not be susceptible to a concentrated exposure to a business sector that suddenly falls out of favor.
By holding positions in investment companies that invest their cash in government securities you will gain exposure to fixed income assets. Investing in companies that build houses or work on large infrastructure projects, exposure to property and construction assets can be simulated.
An international aspect to your portfolio can be achieved by investing in the shares of companies that make most of their earnings in international markets, or even by utilizing ETFs that are themselves invested in international stock markets.
A stock portfolio is a long term investment, and investing regularly helps to drip feed cash in to your investments and takes advantage of the effect of dollar cost averaging. The stock market does not move up in a straight line: by investing at regular intervals shares will be bought when the market cycle is down as well as up, and the average cost of entry benefit accordingly.
Similarly, by reinvesting dividends not required then your portfolio will benefit from the compounding effect of buying more dividend paying shares with dividends already paid.
Monitor and rebalance at regular intervals
To ensure your portfolio is working as you want it to, then it should be monitored at regular intervals. This will allow you to rebalance positions – selling shares in those that have grown to too large a portion of fund value – and keep your portfolio in line with your risk profile.
A properly defined review process will help you to remain focused on your aims, and adjust your diversification across industries and geographies accordingly.
Remember, however, that time should be given for investments to perform, and each time rebalancing or share purchases and sales are made then trading costs will adversely affect portfolio performance. This is why major rebalancing and portfolio adjustments are usually conducted on a biannual or annual basis.
To finish up
It is entirely possible to make a stock portfolio work to meet the wide range of investments objectives and risk profiles, whilst diversifying across industry sectors and encompassing exposure to global markets as well as other asset classes.
By employing consistent valuation methods, and monitoring and reviewing your portfolio at regular intervals, you will be able to maintain its performance over the long term and it will remain in line with your changing investment profile.