Getting started in the investment world might seem a little daunting at first. Potential investors might get bewildered by the sheer number of investment tools available. Some of the tools are mutual funds, exchange-traded funds, target-date funds, a variety of bonds and fixed-income products – and then, of course, good old individual stocks.
A lot of investors today prefer to invest using low cost ETFs. These days more and more investors are turning to low-cost ETFs. That leads to the question, should you spend a good amount of time building an individual stock portfolio. The answer is a resounding yes. Individual stock ownership comes with a lot of distinct advantages, provide you are ready and willing to put the requisite time and research behind it. According to Henry To, partner at the Newport Beach, California based CB Capital Partners: “I believe an individual investor absolutely has an advantage over professional investors if he or she is willing to do the homework necessary to understand the company, management, and the industry underlying each individual stock.” With that said, let’s get started.
Here are the Tips to Help You Build a Stock Portfolio
How should Investors pick the companies on their stock portfolio?
Constructing a good stock portfolio requires time, patience and effort. You will be best served if you can dedicate some time of the day to studying the patterns and historical performance of the stock market. A lot of great and useful information is available for free for potential investors.
The sheer volume of resources on stock investment guidance has increased manifold over the years. Henry To added: “(There are) tougher regulations on information and financial disclosures by company management. This means there now exists a much more level playing field between individual and professional investors when it comes to access to materials information.”
However, even though the amount of great (and free) information on stock market investment might have increased a lot, there is one price you still have to pay, and that’s the price of your time. Unless you spend hours behind designing your portfolio, it will be tough for you to create one that serves your needs.
Always think long term
While developing your plan, always keep the long term view in mind. Henry To uses the example of Starbucks (SBUX) to explain this very well: “The stock has gained 73-fold over the last 20 years. But, the stock was down by 30 percent or more from its two-year high 15 percent of the time. Your holdings will fluctuate, and you must develop an investment process that allows you to keep your conviction during times of volatility and bear markets.”
Part of this long-term view involves having the emotional fortitude to buy and hold stocks you believe in, even – and perhaps especially – when their prices are falling for no good reason.
Use the following parameters when choosing stocks.
- An equity’s strength is also determined by how strong the management team behind it is. The team must possess a proven track record of sticking to their strategies, timelines and execution.
- Secondly, it should have a line of products or services that appeals to its core customer base, with a potential market size to allow long-term growth.
- And finally, the company must be renowned for creating unique products and services that boost the profit margins.
In case some of today’s most popular stocks seem like an option for your portfolio, but they don’t fit the qualifications listed above, then you’ll pay a heavy price for the decision to hold for years on end. Conversely, the firms which have great management teams and create sustainable competitive advantages, have all the qualifications to become solid foundations for your portfolio. With their help, you will be able to beat the market in the long run.
How many stocks should be there in a diverse portfolio?
Diversification of your portfolio is extremely important in the long run. For example, if one of your stocks in a particular sector suffers losses, that can be offset by the gains made by other stocks in a sector witnessing an upswing. A diverse portfolio should have anywhere between 10 to 30 individual stocks. The 10 stock sectors classified by S&P Dow Jones indices are:
- Consumer discretionary
- Consumer staples
- Health care
- Information technology
- Telecommunication services
According to Kelley Wright, managing editor at Carlsbad, California-based Investment Quality Trends newsletter: “As a general rule you would like to own two to three of the top companies in each major sector.”
Stock rankings can be extremely useful
Stock rankings, screeners and lists can help individual investors in their quest to find the best stocks for their needs. The rankings can slice and dice stock market members up by returns, market capitalization, dividend yield, price-to-earnings ratio and other criteria. Investment research isn’t exclusively meant for portfolio and hedge fund managers, and individual investors should do it as well.
Another way to diversify is between growth and value stocks, or between dividend stocks and those focused on plowing their profits back into their operations. Diversification is beautiful because it can lower risk without lowering the expected return of a portfolio which is more or less akin to magic by Wall Street standards.
Be picky with your portfolio
After all, it’s your money that is going to be used to build it. Use your research and common sense to weed out the industries that you do not like in the long run or that have historically lost money due to the lack of differentiation and competitive pressures. According to Henry To: “The mining industry is a perfect example of how an industry has lost money since its inception; airlines is another good example. Do not expect to make decent long-term returns in these industries even if you are able to pick the best or the lowest-cost operator.”
Consider basic behavioral psychology and economics
Having an understanding of the behavioral psychology and economics at play behind the companies you hold in your portfolio can also go a long way in fulfilling your long term investment goals. For example, knowing the demand elasticity, or how much a change in price will impact the quantity demanded, can be useful in understanding a company or industry’s prospects.
Think of this, if gas prices increased by 10% tomorrow, there will not be any drop in demand. Fuel is a necessity and people will be willing (though reluctantly) to pay the premium for it. However, if the price of a particular brand of hair gel goes up 10 percent tomorrow, there will likely be a greater slump in demand, since there are many alternative brands and even other hair products that can act as substitutes.
Establish an investment time frame
As per Kelley Wright: “If you are going to own individual stocks you need at least three to five years, the longer the better to lessen the inevitable volatility.” Remember to know what you want. “To be successful in individual stock investing, you must do your homework, but more importantly, you need to have a calm temperament and trust and be confident in your own convictions and analyses. Do not let others spook you,” says Henry To.
Building your portfolio may be just the beginning. But, for the interested and dedicated investor, the payoffs could be well worth the work.
Selecting the right stocks for your portfolio that can fulfill your investment goals takes time and effort and doesn’t happen overnight. You need to evaluate many parameters for the stock, industry and overall economy. DJ Verhaalen, senior financial advisor at U.S. Bancorp Investments in Milwaukee says: “Investors today have many tools at their fingertips to make sound decisions; stock screeners, publications and brokerage firm research to name a few. Building a portfolio is just the start. Ongoing research and review is required to make sure the stocks are still appropriate and aligned with your goals.”
There is one thing that you must remember, if you want your portfolio to be able to beat the market in the long run, you need to pay your proverbial dues and put in the hard work and research behind it. No amount of quick hacks or shortcuts to portfolio building tips can help you in the long run. You should also be willing to take a certain amount of risks on the way. And perhaps most importantly, you need to have the patience to hold on to your stocks for a long time, even though the prices seem to be going against you for a significant amount of time. Yes, a few dividend stocks can generate some good interest income, but the real dividends will eventually arrive in the form of long term gains that will pile up on top of your ever growing investment corpus. Hope this post helps you give you a basic understanding of stock portfolio building and with your investment journey in the long run. Good Luck!