In today’s article, we are exploring how to create a portfolio. This is actually very important for any investors because a portfolio will help us determine the kind of expected returns and the level of risk we face. For example, if you choose a portfolio that is full of “blue chip” stocks, you can expect lower returns compared to a portfolio of growth stocks. However, a portfolio of “blue chip” stocks will also be likely to have lower risk as they are generally less volatile than growth stocks. What we are after ideally, is a balance of risk and reward when it comes to investing.
Types of Portfolio
What you need to know about the type of portfolios is that there are many. For example, you can have a 100% equity-based portfolio or even a 100% commodities based portfolio or anything in between them. We’ll focus on 3 types that could be suitable for investors like us!
For stock-based portfolio, it’s usually 100% of the common stocks in the stock market. This particular type of portfolio is more suitable for investors who want to select individual stocks and form their own unique portfolio. What’s interesting to note is that most investment gurus adopt this type of portfolio in an attempt to beat market returns.
They do extensive research on individual companies and select the “cream of the crop” to be in their portfolio. Depending on the investment amount, an individual investor may have 10-30 stocks in their stock-based portfolio. It’s not recommended to have more than 30 stocks unless you are very well-versed in analysing companies and have the time to do so.
Also known as the “Do-It-For-Me” portfolio, investors may consider this particular portfolio when they do not want to select their own stocks and do not mind paying a fee for others to select a stock for them. In the past, the type of funds available for investors are unit trust and mutual funds which are actively managed by fund managers. However, these funds usually come with a steep management fee, ranging from 0.5% to 3%. However, there is a new kid on the block – Exchange Traded Funds.
ETFs are basically funds that are traded in the stock market like a common stock, except that it tracks a particular index. For example, the SPDR® Straits Times Index ETF tracks the performance of the Straits Times Index , while the SPDR® S&P 500® ETF tracks the performance of the S&P 500® Index which consists of the 500 largest US listed companies. The good news is we can invest in both of these ETFs through the local stock market (check that your stock brokerage firm allows you to invest in ETF too!)
A blended portfolio is essentially a combination of stock-based and fund-based portfolio.
This allows the investors to select individual stocks while tapping on the benefits of an ETF (e.g. low cost and diversification). For example, we could invest in 50% of our portfolio in individual stocks to tap on the growth or value of each company and invest the remaining 50% in an ETF such as SPDR® S&P 500® ETF to seek returns of the overall US market which helps to diversify the portfolio too.
Features of a Portfolio
Now that we have a better understanding on the different types of portfolio, our next step is to decide on the three important features in order to increase the likelihood of success for investing.
This is the first and most important feature of a portfolio. We must form a set of rules to govern our way of investing. This is to ensure that we invest consistently and are unaffected by noise or emotions. An example of this would the rules in selecting value stocks. We can base it on the set of rules to select which stock or ETFs to include in our portfolio. If any stock doesn’t meet the rules, chuck it away. A very strict and important point to note is to never ever bend the rules to include a stock that you “like”. Just because you like Apple and use Apple products daily, it doesn’t make Apple stock a good fit for your portfolio. You must always check their financial and business first.
The allocation between stocks and funds in your portfolio largely depends on your acceptable risk level and approach towards investing. There is no hard science to this so a few examples will be shared to illustrate it further. For example, if we wish to create a stock-based portfolio of 20 individual stocks, we can allocate 5% of the overall portfolio to each stock. This will spread our risk evenly across all 20 stocks however it also averages out any returns across all 20 stocks too. In short, if a stock collapse, we will only lose 5% but if a stock were to double up, our portfolio will only gain 5% too. In the case of a blended portfolio, we could allocate 80% of our portfolio to an ETF to invest in the overall stock market and seek market-level returns. The remaining 20% could be invested in individual stocks if we are beginning with value investing and want to hone our skills further. Allocating just 20% to individual stocks will protect the majority of your portfolio while standing a chance to gain from selecting individual stocks.
After we have allocated the portfolio accordingly, it is important to rebalance the portfolio periodically. This is to ensure that our portfolio is not overly weighted in certain stocks or funds. For example, in a $100 portfolio that is evenly distributed across 10 stocks, if Stock ABC’s price doubles up from $10 to $20 over a year while the rest of the stocks remained the same, Stock ABC will now represent 18% of your total portfolio ($20/$110). Therefore, we should rebalance our portfolio by selling some of Stock ABC to return the percentage of Stock ABC in our portfolio to 10% again. This will prevent any severe drop in Stock ABC from affecting the portfolio too much. It also cultivates the behaviour of “taking money off the table” when you are gaining in your portfolio.
Regardless of the type of portfolio, the three features of Rules, Allocation and Rebalancing will ensure a consistent performance of your investment. In the stock market, consistency is most desired. If the success of a portfolio cannot be replicated, it is likely a fluke, an outlier. What we want is to perform consistently in the stock market so that we can gain positive returns over time.
If you felt that you have learned something meaningful from this article, why not put the knowledge to good use by starting to build your own portfolio?
You can do so by attending our FREE value investing masterclass to learn how to start investing in Singapore, as well as pick out some high growth dividend stocks to grow your portfolio!