13 December 2011

Some Guidelines on Constructing a Stock Portfolio

From my previous post - Why do we construct a stock portfolio, now I would like to share with you on how to construct a stock portfolio.

Based on my previous experience, I found out that constantly performing a portfolio rebalancing at least once a year would beat the 'Buy and Hold' strategy unless you can find some extraordinary shares that can beat others in long run. So, with portfolio rebalancing in place (e.g. Buy and Sell to maintain a Strategic Asset Allocation ratio is crucial to stay through the up & down of the market).

In Singapore/Malaysia, you do not need to pay for the capital gain. So it really depends on you on how to take profit and cut loss depends on the market condition. The Thumb of Rules on constructing a stock portfolio is shown as below:

Maximum % of Stock in your Portfolio = 100 - Your Age

For example, if you are a newbie investor, then above rule is quite good for you. This is based on the assumption that your potential Total earnings will be reduced over time and you need more cash flow when you are reaching retirement age.

However, this is based on your 'mentality' and 'risk-adversion attitude' towards 'unrealized gain/losses'. I was once near to 100% invested all my cash in stock portfolio. I also borrowed money from my parents to buy shares and able to return money to them after few months later. Why was I able to do so? This was because I invested in shares since I was very young and at that time I lost a big portion of money in the stock market. However, as I started to work and able to get more cash flows, I used it to put it in the stock market and treat it as a long term investment. Once you started to invest with a smaller amount, the amount that you lose in the stock market will not be much. Then you can start investing like 'Monthly-Investment-Plan', which allow you to continuously put in the money in the stock market as and when you have the extra money after deducting the daily expenses budget.

Next, once you started to invest in monthly basis, then you would be able to keep on monitoring the market movement and decide whether to sell or buy. Normally I would encourage you to do homework on the stocks you buy before you invest into it. This is because stock portfolio is different from Unit Trust, as you will be facing concentration risk. However, you can reduce those risk by investigating in details on the stocks that you are interested. The first rule would be 'Make sure the company will not go bankrupt or delisted'. You can only buy the 'Good Quality' stock. How to know whether this stock is in a good quality?

1. Consistently higher ROE compared to the peers.
2. Able to generate cash flows / dividends in consistent matters.
3. Able to grow sustainably in long run.
4. The management focus on their core business for quite a long period.
5. The management has the integrity and responsible to the small shareholders.

Once you get the 'Good Quality' stock, then you can start accumulating the stocks in a portfolio. Normally I would suggest you not to hold more than 35% for a stock in a portfolio when you just started to investing, even if you look very good on this business, but the good thing of being a shareholder is to know to sell your shares when market condition changes.

Try not to concentrate on one sector for your whole portfolio, as you may experience a huge volatility of the portfolio value. What you need to do is to pick the best stock in that sector and select another best stock in other sector. You will then be more comfortable on investing in long run.

Cash - Stock Percentage in the Portfolio is crucial, as you can reduce the risk of not able to 'Buy in Bear Market' or not able to 'Sell in Bull Market'. I would encourage you to manage a Cash - Stock percentage in 25:75 to 75:25 ratio, so you will not be too over confident or too over pessimitive to the current market.

If you ask me, why would I risk myself to invest in a downturn? My answer is - I cannot tell when is the best time to buy / sell. But I believe that the revenue and net profit will be growing in long run (say, 10 years) and if you have a long term investment horizon, then you should be able to Buy at Low Prices and Sell at High Prices.

Welcome for your feedback. Have a nice day. :)

1 comment:

  1. The article introduces the topic very well and in a layman language about the stock markets. Would like to know more about this in your next series.


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