Creating your investment portfolio for the long term doesn’t sound that hard, does it? Except for the fact that most investors fail to do so. They lack self-discipline and patience to invest successfully in the long run.
With this article, I would like to help you create your portfolio that can stand strong for a long time.
Steps I’ll be discussing:
- Ask yourself the basic investment questions
- Choose your stocks wisely
- Track and rebalance your portfolio
1. Ask yourself the basic investment questions
Why do you want to consider investing? Obviously, it’s to earn money, isn’t it? But what’s the ultimate purpose? Do you want to invest for your retirement, or is it to buy your new home? A lot of the answer also depends upon your age group and financial position. A 20-year-old studying in a college will need to have a different strategy than a 50-year-old who wants to send his or her children to college. Also, a person who is in a good financial position is able to risk more than a person who doesn’t have much wealth.
You have got to be clear with the purpose of your investment. Without answering the “WHY” question, you won’t be able to stick with your goals that would follow.
After that, ask yourself for how long do you want to invest? When you say ‘for the long run’, how long do you mean? 10 years? 20 years? Do remember that the longer your investment horizon, the harder it will be. It’s because you will need to show more self-discipline and patience with your portfolio.
Another important question is to understand your risk tolerance. How much risk are you able to tolerate? Would you be able to remain patient when the market drops by 50%? Will you hurriedly sell your stock if you see a 10% gain in its price? The more risk you are willing to take, the higher return you can achieve. But most of the time, the possibility of higher returns comes with the expense of suffering even more losses. Talking about myself, I can’t sustain too much risk. So I choose my investment portfolio to consist of less risky stocks.
“Stick to your investment strategy Do Not Turn Temporary Declines Into Permanent Losses.”Warren Buffet
2. Choose your stocks wisely
This is the most exciting yet the most difficult part. After answering the basic investment questions, it’s now time to make the decision. If you are starting out your investment journey, then I beg you not to make the same mistakes as I did when I started.
Screening the stocks
You can’t analyze each and every stock out there. It’s just too much. But don’t worry, after screening the stocks, you will eliminate most of the stocks. Benjamin Graham’s Intelligent Investor provides an in-depth insight into stocks screening. The following are a few of the screening tools you should consider:
- Market capitalization: According to Investopedia, Market capitalization refers to the total dollar market value of a company’s outstanding shares of stock. Commonly referred to as “market cap,” it is calculated by multiplying the total number of a company’s outstanding shares by the current market price of one share. Choose your ideal market cap from large-cap, mid-cap, and small-cap. As you are creating your investment portfolio for the long run, try to have a few stocks from each category.
- Financial ratios: Ratios such as earnings per share (EPS) and price-earnings ratio (P/E ratio) are commonly used. For most investors, a high EPS and a low P/E ratio indicate a good company. But if you are an aggressive investor who is looking for a high growth rate, then you should consider a high P/E ratio.
- Sector: There are plenty of sectors to choose from. The most common ones are banking and finance, technology, manufacturing, and retail businesses. You should try to stick with only those sectors which you have knowledge about. Considering my personal example, I don’t know much about manufacturing businesses. So I stay away from those stocks.
Do you even want to buy stocks first of all?
If you aren’t satisfied with the stock screening process, there are other popular alternatives you could consider:
- Bonds – They are the main competitors for stocks. Bonds pay the investors a regular fixed amount of money every year (or as mentioned). They are popular mainly because investing in bonds is much less time consuming than in stocks.
- Mutual funds – They are the collection of funds that are managed by finance professionals. Most mutual fund managers are experienced in their field, so you won’t have to burden yourself by tracking your portfolio continuously.
- Fixed deposits – This is the easiest and least time consuming of all. You have to just deposit your money in a bank for the long term. In return, you will earn some interest.
3. Track and rebalance your portfolio
Once you have picked your stocks, you have to track your portfolio. You will need to rebalance your portfolio periodically by buying and selling a few stocks.
My personal strategy: My strategy is to sell my stocks if their prices increase by more than 50%. Then, I try to buy the ones whose values are decreasing and available at a cheaper price.
Also, portfolio weightage is an important tool to consider. Let’s say, 50% of your portfolio consists of stocks, 20% bonds, 10% mutual funds, 10% fixed deposits, and 10% others. Due to market volatility, your weightage position will change at times. Your 50% of stock holdings could increase to 60%. In that situation, you should consider selling 10% of your stocks to rebalance your portfolio.
“Most of the time common stocks are subject to irrational and excessive price fluctuations in both directions as the consequence of the ingrained tendency of most people to speculate or gamble.”Benjamin Graham
Throughout your investment journey, you should always consider diversifying your portfolio. You should diversify based on the stock class, sector-wise, weightage-wise, and so on. Try to hold bonds and other assets class alongside stocks. Overall, a properly diversified portfolio gives you the best opportunity to enjoy stable long term growth.