How to Build a Share Portfolio
Building and managing your own portfolio is one of the challenges of running a SMSF or using an online broker. Whilst every portfolio is different the overall structure and configuration will depend on your personal financial objectives, motives and interests. Before bulding your own portfolio we encourage you read our research article about the risks and benefits of investing in the stock market.
This guide will provide you with a few practical tips on how to build your portfolio. This is general advice only and should not be understood as personal advice. Please read our disclaimer for further details.
Start with Education: Understand How to Analyse Companies
Before getting started you should educate yourself on how to research and evaluate companies or pay someone to do the research for you. We discourage individual investors to purchase stocks solely based on rumours, news articles or recommendations from friends. Even if you have an expert by your side, your own judgement, research and analysis is invaluable if you want to succeed in the market. Making mistakes can be expensive, however every investor in the world has lost money at some point during their investment endeavour.
Choosing the Appropriate Risk, Strategy and Investment Size
As each portfolio is different, before purchasing your first stock you need to ask yourself a few key questions. We encourage you to think about what kind of investor you want to be and what your objectives are as this will help you determine to find the appropriate size for your investments. We can’t advise on how much risk you should take as this will solely depend on you and your willingness to take risk. To get started ask yourself the following questions:
What’s my portfolio size?
How much of my savings am I willing to “risk” in the stock market?
What’s my risk profile? Conservative, low risk or high risk?
Do I want capital growth or income or both?
What’s my objective? (How much return do I expect)
- Am I fully aware of the risk and benefits of investing in the stock market?
Before you purchase stocks make sure you can answer these questions so that you have a basic strategy in place. Once you have decided how much of your total net worth you are willing to invest, you need to decide how much you want to invest in each individual position. This can be a very complex issue and if you are not entirely sure of what you do, it is best to talk to a financial advisor or planner.
Here's a few practical tips that can assist you in your decision making process:
- Have a look at the sector breakdown and weighting of all sectors on the ASX200. The benchmark index represents the largest 200 companies in Australia and is a good start to get a basic understanding of our economy
- Blue-chip stocks are generally good for yield, while small-mid cap stocks offer great potential for capital growth
- We generally recommend that speculative stocks should only represent a relatively small portion of your portfolio
- The old saying of “only risk what you can afford to lose” may not apply to everyone but it is a good reminder of the risks that come with investing
- Determine if the company you intend to buy is a 'high-risk' or 'low-risk' stock
Establishing a diversified portfolio is important as it allows you to diversify your risk across different companies, sectors, industries or even countries. If you put all or most your money in one stock you will be fully exposed to the risks and rewards of that particular company. Any movement in the share price will greatly affect the overall performance of your entire portfolio. There are endless stories of established so called “safe” blue-chip companies which have declined in value even though analysts called them “safe investments”. This is example is not too scare you off but simply a reminder that you can protect your capital by splitting your investments across different companies. “Do not put all your eggs in one basket" is a famous saying of Warren Buffet, one of the most successful investors to date.
We recommend that you consider having at least seven uncorrelated stocks in your portfolio. Seven stocks can help you to reduce your risk significantly and achieve healthy diversification. We believe having up to 20 companies can be beneficial which we consider to be the upper limit. If you own more stocks the advantage of additional diversification is only marginal and may be offset by transaction costs.
Common Mistakes for Diversification
If you buy stocks that belong to the same industry (e.g. all four big banks) you will not achieve diversification in a way that it will likely support your risk management. Also, excessive diversification or over-diversification will likely be inefficient and lower your returns. If you own too many companies you increase your costs but not necessarily your degree of diversification which may ultimately lead to below-average risk-adjusted returns. In that sense an inexperienced financial planner or advisor can help you to build your portfolio if you are unable to cope with that step.
According to the ASX the average return of Australian shares is a gross return of 9.7% over time. However with the wrong strategy, poor diversification, inappropriate position sizes or excessive trading many investors would have not achieved a return anywhere near the average. Understanding the basic principles of building a portfolio can assist you greatly in benefiting from the market conditions and achieving long-term returns. Ultimately your performance will depend on the performance of your investments and the market itself, however with the right strategy in place you can minimise the risk to those factors that are out of your control. If you don’t feel comfortable or you don’t have the time to manage your own portfolio we recommend you engage with a financial advisor or planner.
Disclaimer: This article should not be considered as general advice only and not understood as personal advice. Wise-owl is not able to advise on how to work out your individual risk profile. We can only provide you with general advice on listed securities and can therefore only comment on matters related to the sharemarket. If you are looking for more complex issues such as asset allocation between stocks, property, fixed interest or bonds then we recommend you see a financial advisor or financial planner.