Unity in Diversity: How to build and diversify your portfolio
“If you build it, he will come.” While the saying hails from a late 80’s baseball movie, it can equally apply to your stock portfolio. But what the quote didn’t go on to tell the Iowa corn farmer, is that building takes effort, insight, and (for the Singaporean stock investor) a healthy dose of diversification, before profit comes into play.
Building Basics
When it comes to building a portfolio, it is well to remember that “one size does not fit all”. Investors are different from each other and will invest accordingly: the two main differentiators are the age and financial situation of the investor, and his or her personality or investment style.
An investor in his 20’s who probably doesn’t have much to invest yet, isn’t very likely to invest the same way as, say, an investor approaching retirement age who wants to see his son through medical school. Again, some investors are risk-takers who enjoy “living on the trading edge”, whereas others like to play it safe on the bourse.
Asset Assessment
An investor who has defined the two main differentiators above for himself, should now be able to figure out which asset classes he will be investing in. The three main classes are
- Equities or stocks
- Fixed-income assets or bonds
- Cash equivalents or currency market instruments
Once an investor has decided which assets he wants to invest in, he can now allocate portions of his capital to each. While we’ll be focusing on stocks in this article, it’s good to bear in mind that your portfolio can also include the other two types of assets.
Finding Factors
When finding the right stocks to build your portfolio, it’s a good idea to consider these four factors as described by one of the authors for a major US-based asset-management firm:
1. Value. This factor has to be looked at very carefully when choosing stocks, for the simple reason that a stock’s value may not be as high or low as it really ought to be. Make sure you consider the solidity of a company’s fundamentals, as well as its share prices, before adding its stocks to your portfolio.
2. Momentum. These are the stocks that investors buy when they are going up, and sell when they are going down. This “following the herd” mentality works up to a certain point, that point being if and when the momentum stops. While these stocks are therefore risky in that regard, this factor can be still considered with care when building your portfolio.
3. Size. It is interesting to note the fact that there are more, smaller cap stocks compared to the number of large cap stocks. Since many of these smaller stocks are not as well-known even by sophisticated investors, the opportunity that these small caps present is quite significant. These stocks, however, are also rather risky compared to others, and as such should also be more carefully considered.
4. Quality. These are known as the “old reliable” stocks because their prices more or less remain steady. Investors usually overlook these old reliables until some market crisis or other causes most everyone to want nothing but old reliables. As they are usually overlooked for being “safe and boring”, these stocks are potential winners in terms of incremental returns.
Diversify and Conquer
The principle behind diversifying your portfolio as you build it is as simple as another, even older saying: “Don’t put all your eggs in one basket.” The reality is that you never know what might happen in the market, or in the news that might affect the market. Very simply, diversifying the kinds of shares you buy can help minimise any damage that might be sustained.
Here are a few simple ways from Investopedia on how to diversify:
1. Go for the combo. Instead of investing in just one company or sector, invest in a combination of companies from a variety of industries that you know and trust.
2. The name is bond… As the second asset class listed earlier, fixed-income assets or bonds can be a good way to safeguard against market uncertainty. Index funds, or securities that track an index, are another recommended long-term diversification tool.
3. Keep up the pace. Add to your investment on a regular basis while following a fixed schedule. This helps lessen the risk of investing a huge amount in a single investment at the wrong time.
4. Keep tabs on the market. While some people advocate a “set and forget” approach to investing, it is highly advisable to stay up to date with the companies you have invested in. If you see a good opportunity for profit-taking, it may be a good time to pull out.
Sage Stock Advice
While there may be no hard and fast rules for portfolio building and diversification, there is no shortage of advice. Top financial advisers in the UK shared some words of wisdom with The Telegraph on some of the best ways to build and diversify your portfolio. Their advice included:
1. Going against the grain. Many retail investors and professionals buy high and sell low instead of the other way around. It may also be better to buy low-cost assets and let them work for you over a longer period of time, instead of buying and losing out on high-priced assets.
2. Going long-term. Investing for the long term involves fewer risks than short-term speculation.
3. Not trading too frequently. Too-frequent trading could increase your costs, but it is equally unadvisable to review your portfolio very seldom. Taking a look at your portfolio only once every X number of years could mean some serious losses that could have been avoided.
4. Not getting too attached. Some investors might hold on to certain stocks for “sentimental reasons”. While there is nothing wrong with that, it could cause them to sustain heavy losses if those stocks don’t perform well on the bourse for extended periods.
5. Looking to the past. A stock’s past performance is a good indicator of how it is going to perform in the future. Keeping your gainers and selling your losing shares will be more profitable for you in the long run.
Sophisticated Investor Savvy
Building and diversifying your portfolio doesn’t happen in a vacuum. As advocated by Investopedia above, keeping tabs on the goings-on in the market around you is a good way to diversify. This includes tracking the trading activity of sophisticated investors, which can be easily done in real-time using the Spiking app.
With Spiking, investors will be able to see which stocks are on the move among more than 8,000 top investors in Singapore. These stocks could very well be the next additions to your growing portfolio. With the right combination of stocks and other assets, as well as a level-headed, deliberate approach, you should be able to build your portfolio into an investment edifice able to stand the test of time.