There are plenty of comments about a good investment but few about how to build a good stock portfolio. This is a shame, because no matter how much research you do, something can always go wrong. Diversifying your holdings with a margin of safety means that over the long-term, your portfolio will grow without giving you too many heart attacks.
What is a good stock portfolio
What guidelines will serve you well
How to build a model portfolio
A stock portfolio is a collection of different stocks. Due to the high risk nature of equities, they can lose 50% of their value in a matter of minutes, most stock holders will diversify their capital over a minimum of 20 holdings. This creates a portfolio of stocks.
The long-term average growth rate of the USA’s most quoted stock market is approximately 10% a year. Yet depending on which study and how many years back you include, this can vary. Either way, it is feasible to assume an 8-10% return on one of the major Western stock markets.
Such an (approximate) return is attractive comparable to the 0% yield available virtually every where else, be it cash or bonds. The internet has also opened up investing to do-it-yourself investors. Many listed companies are present in our day-to-day lives. If you like their product and service, maybe they are worth investing in?
Although many investors will first think about what to buy, they should actually plan first. Putting all your money in one stock or sector is inviting trouble. Ideally you will place no more than 30% of your portfolio in one sector, such as technology or renewable energy. It would be advisable to hold at least 5 sectors which ideally are not correlated.
You should also plan to hold some cash, somewhere around 5%, at the most 10%, which can be used to take advantage of new unforeseen opportunities. Some investors may also be interested in holding some gold or governments bonds, as a hedge against stock volatility and portfolio protection.
You should be careful with this assumption though, during the Coronavirus March 2020 sell off, gold and US treasuries also sold off as investors scrambled for cash, most likely to meet margin calls.
Although it may be tempting to place all your portfolio in Big Tech, environmentally friendly stocks, renewable energy and stocks with good social governance, these thematic investing stocks are fashionable trends. As a result they may already have ‘had their moment’ with the corresponding share price growth. It would be a good idea, as part of a balanced and disciplined approach to ensure you hold some core holdings. This would include your home stock market in the form of ETF (a passive investment) and maybe one or two of the major foreign ones such as the S&P500 and/or the STOXX 50.
Once you have reached this stage is when you get to have some fun. Picking stocks can be fun when you see them go up. Of course, there is a downside risk to this too, they can go down… and even become insolvent. To protect you from the worst, there are sensible guidelines to follow.
Limit your position size to the following. If you are buying a Large Cap, e.g. one listed on the FTSE100, then the maximum holding size should be 5% of your total portfolio. If buying a Mid Cap, i.e. listed on the FTSE250, then you should limit yourself to 2% of the total value of your portfolio.
These guidelines are in relation to risk. Large Caps are less volatile than Mid Caps. Small Caps are like the wild west, be very careful about investing in this area. Small caps can lose virtually all their value in a matter of weeks and even days. This happens easily when they are loss making and their ‘big idea’ fails to come through.
Although buying and selling equities can be fun, they are risky and you can lose a lot of capital. Another way of buying them, is through mutual funds and an investment trust.
Both of these vehicles have the advantage of providing you with an exposure to a diversified portfolio of holdings, with an ability to check the investment performance of the portfolio manager. Many funds will also specialise in a particular sector or market giving your portfolio focus.
In both cases, holding up to 10% of your portfolio of one fund is suitable, although the more risk adverse may choose to limit this to 6-8% of the total value of your portfolio.
Investing your capital can be daunting for a first-time investor. As a rule it is best to place your money into the stock market in stages. For example, you may choose to place half immediately and half at a later date. Or a third every 3 months.
Finally some investors will drip feed it position-by-position over 12 months to buy the dip. Every investor is different and you will have to understand who you are. You may find that your first investments you made are no longer relevant by the time you finish investing your initial capital, and choose to do a sector rotation.
Your stock portfolio will only perform if you diversify it. Although you may hold funds in different sectors, you will often see the major Big Tech names appearing in most funds. You could end up with 10% of your stock portfolio exposed to one equity, as each fund you buy may hold a position in it!
Finally, be VERY cautious investing with a hedge fund manager or alternative investments. Every 10 years they become all the rage, and every 10 years investors realise they are no use. The only one who makes money is the portfolio manager running it.
Remember your stock portfolio should allow you to sleep easily at night, whilst being sufficiently diversified to avoid creating a hole in your capital, because a stock or sector has blown up.