Building your own stock portfolio – Know the ground rules first

So you have finally decided that you need to invest in stocks. You have defined an amount you can spend, have got a Demat and a Trading account in place and may even have signed up with a broker or some financial adviser to help you select stocks. However, before you take the plunge ans start investing, there are a few critical ground rules that you must keep in mind. This post ia about such rules to be remembered.

  • You will always look to build a portfolio pf stocks and be concerned about performance of portfolio. The portfolio approach is the most important aspect of equity investing. The basic idea is this – as you spread your investment over multiple stocks in multiple sectors, the scale of the risk in each of these is contained. So at an overall portfolio level you have a lower risk of losses. We will discuss on how to build a portfolio at a later date.
  • Ideally no stock should be more than 10 % or less than 2 % of your portfolio value in the long run. All of us will have our own favorite companies whose shares we want to buy. However, if we cap the investment at not more than 5 % of the portfolio value then we are once again containing the risk. Similarly, by investing at least 1 % of the portfolio value in a stock, you are ensuring that the investment is at a meaningful level.
  • You do not need to analyse companies yourself but must have access to the right information. Many people may have told you that you must read tons of financial information and understand every word of the Balance sheet before you can invest in a company. That is completely unnecessary and frankly it is an utter waste of time. Do not reinvent the wheel – there are far better qualified people than you who can do this well. All you need is to have access to such data and an ability to understand simple stuff well.
  • Always buy in small lots and with price triggers for both buying and selling. In stocks it is very important to understand that pricing is dynamic and is impossible to predict in the short run. It therefore does not make any sense to invest a large amount at one go. You can decide on what is a large amount based on the portfolio value that you want to create. We will be discussing this in much greater detail at a later point in time. Also, you must set price triggers for both buying and selling – this will take away the emotion from the decision and enable you to carry out trade calmly.
  • All profits and losses are notional till you make a sale. The value of your portfolio will be changing everyday and it can be like a roller coaster ride emotionally. While we will get elated when it rises by 3 % on a single day, it will be emotionally gut wrenching to see it nose dive by the same amount on other days. Remember that you do not make or lose money till you actually sell. On many days doing nothing can be the best solution.
  • Never bring yourself to a situation so that you have to sell stocks at the wrong time. The most serious risk in stock markets is that we may sometimes be forced to redeem part of our portfolio at the wrong time, as we need the money for some emergency. Your financial plan must address this issue squarely and make sure that you will have other sources of obtaining this money even if there is an emergency.
  • You will make both right and wrong calls on individual stocks do not worry about it. You must always evaluate your portfolio performance, it is impossible for most people to get even 70 % of their stock picks correct. Even if you get half of your stock picks correct for your portfolio, you will make a great deal of money from it.
  • Review your stocks in the portfolio every month / quarter but do not be obsessed with it.
  • You need to try and buy stocks at the right price and also hold these for as long as practical.
  • Do not be sentimental about any stock, if the review shows it has to be got rid of, do so immediately.

We will get into more specific aspects of building a high performing stock portfolio, the next post onward.

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6 thoughts on “Building your own stock portfolio – Know the ground rules first

  1. SIr, I agree with your overall philosophy. My response is from the point of view of a part-time low networth individual, One point is, if you say that a single stock should not exceed 5% of the investment, it obviously implies that you should have AT LEAST 20 stocks in your portfolio. The common belief is that a highly diverse portfolio cushions you in a downward phase- but it in reality just spreads the investment thin. If cushioning and safety are the main concerns, one may as well get in to a mutual fund.
    I personally prefer, for a part-time low networth individual, a portfolio of around 12 stocks so that the individual is able to well keep track of the newsflow and learn about the overall business models of the companies. Too many companies will ultimately just replicate the index movement,

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  2. […] So which are the sectors that you will choose? I think to start with, 6-8 sectors are enough for a first time portfolio. You should be investing in these sectors over a period of 2 years or so to build up a basic portfolio. Once that is done, it is really a case of maintaining it and reviewing it annually. As time goes by you can add more sectors and companies but do remember that you will need to keep the ground rules discussed here. […]

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  3. Sir,
    I read your blog regularly. Appreciate your efforts in spreading financial awareness.
    Had a query.
    I can understand the buying price trigger.. I didnt understand the concept of selling price trigger ,
    esp when a stock is making profit. Its perfectly right for selling price triggers for stocks making losses.
    My question is if the selling trigger price for stocks is set at say arbitrarily at 35 % for stocks making profit— then wont we be missing out on multibaggers?
    As everyone famously gives example of INFOSYS BEING WORTH IN CRORES IF INVESTED SAY 10000 during its ipo. If price trigger for selling was kept one would have booked out profit at 13500
    Please guide

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