Building Your Stock Portfolio, One Step at a TimeAn Acceler8now.com Investing Education Resource July, 2007
We have two other articles (access them this link and this one), at this point, that have dealt with the risk-hedging strategy of portfolio diversification. You see how important that is? The reason is, it's not all just about investing, not even about high returns, but about achieving long-term success. If you earn good returns today and all vanishes tomorrow, have you done it? Or didn't we say there was some risk to the markets? It's important to earn returns and also be in a position to withstand market shocks. Life brings its tests, you know. Your overall investment portfolio is likely to include other financial assets beyond stocks - bonds (fixed income-earning), deposits or treasury instruments (more liquidity), real estate (another earnings stream, of high potential), etc. Building these investment options into a solid basket is where sound investment strategy comes in. Diversification is implemented, first at the level of the overall asset portfolio, by introducing specific proportions of various asset classes. The next stage is achieving diversification within each asset class. Here, let's focus further on the stock component. It's been said that you need to design a portfolio, based on risk, income and investor preferences peculiar to you. Given that, for many investors, the resources to deploy could be very limited - meaning that they can hardly achieve a significant spread immediately - what can be done by the individual investor to still apply the principles of diversification and enjoy its benefit? Well, for the small investor, the need to protect the investment is even more compelling, implying that the limited resources will not vitiate the desire for a stable portfolio. Whatever the amount you are investing, you still need to understand the character of various stock and sectors of the market and choose where to spread your funds to. Some companies are called blue chips (Guinness, Nestle, etc), and that's not for nothing. They are tested companies with strong financials. Do they necessarily yield the highest returns? Definitely, not necessarily. Some companies are growth companies, showing a lot of future potentials but yet to have a strong and established track record. Possibly you would think of Oceanic Bank, Access Bank, Bank PHB, among others, as being in this category. Some companies are in troubled sectors, affected by government policy shifts or other factors that have toughened their operating environment, leading to declining fortunes (textiles, though about to enjoy a lifeline). Others are in recovering sectors (pharmaceuticals?). Some are on the verge of significant shifts (insurance, for instance). Some pay regular and sizeable dividends (Nestle, Mobil, etc), some are more regular with bonus issues, while some leave shareholders on a diet. The point here is that you need to get to know more about the companies listed on our stock exchange, if that's where you want to invest. With a better knowledge of the companies, it becomes more meaningful to begin to figure out what you want to put in your portfolio. Your first job was to decide on the proportion of your investments to hold in stocks, because you wouldn't rightly put all your eggs in that single basket. Now you have to build the composition of that stock component. What can you accommodate? The idea is not to buy all listed stocks. Or even from every sector. You buy those that offer a specific benefit in meeting your income, risk diversification and other portfolio goals. Do you need some property sector stocks for a hold on the property market as a way of diversifying into that sector, especially if you have no specific allocation for real estate investments? Do you take some banking stocks, not only because they have continued to turn in good returns, but also for liquidity (bank stocks trade heavily due to regular demand)? Besides, when the money market steals the show from the capital market, you're still in business as a bank owner (yes, that's what you are as a bank shareholder). Can you accommodate some high-level blue chips, for stability, knowing that only the worst situations will substantially affect them? Do you want to add some high-growth, high-yield but less proven companies that boost your earnings possibly at some more risk? A key principle in all this is to aim at a portfolio of stocks that are not similarly affected by market factors. You want a situation where, unless there is a total market crash, your portfolio will be having winning and, possibly, losing stocks but certainly not just losers. You want to earn good returns, but not necessarily the highest returns, because you also want to spread your risk, in a reasonable way. Today, a number of investors may just be exclusively holding banking stocks, in the expectation of high returns, not asking what happens if the sector suffers a sectoral setback. Your goal won't be achieved overnight, that's why we speak of a one-step-a-day approach. Keep an eye on the result you want and, based on available funding, add the next stock that improves your portfolio strength. That way, you will gradually be shifting towards the ideal portfolio you want to build. Your portfolio structure is for a purpose, so you won't make the mistake of regretting not putting all your money into one stock that suddenly emerges with some run-away success. You can't win all the time and should be satisfied if your portfolio meets your objective. Otherwise, re-balance it, especially if your goals have shifted or the market situation demands it. Having done that, be happy with your results. Investing is not strictly about getting the highest returns in the market. You want to be relatively comfortable on a rainy day. |
The composition - achieved through the process referred to as asset allocation - would be expected to reflect personal preferences. If you take the hypothetical allocation shown here, expect a young investor, with a clearly aggressive investment outlook (because he still has a lot of time in his hands), to possibly shoot for a much higher stocks component. That opens him to the potential for more earnings but with a higher risk exposure. Even at that, it would be prudent to accommodate other asset classes to cushion that risk. On the other hand, expect the investor approaching retirement to get more cautious and place higher premium on safety of principal. That indicates a shift to a higher allocation to bonds and real estate. For you, what should be the shape of your portfolio? You need to work through the process, though there is always the option of seeking the professional services of an investment adviser.
