Putting together a portfolio of investments is like building a home. Even if a house is filled with beautiful rooms that may not be enough: All those rooms need to work together to form a pleasing and useful whole. Investment portfolios work the same way.
In the same way, there’s more to successful portfolio building than picking good investments. Here is a basic primer on how to sort out your investments and give your portfolio clarity.
1) Commit to a purpose.
Just as building a home begins with a blueprint, you need a pattern for your portfolio. The blueprint tells the builder to build a structure of a particular size and shape, with specific features, to suit the needs of its future owners. Similarly, your portfolio should suit your needs and specifications.
The best starting point is to think about why you're investing in the first place. Have an end goal. This would be very personal. Is it your retirement or your child's education or a second home? Your goals will give you the vital information needed to make a sound decision. How much money do you need to save? How much time do you have?
Once you get clarity on what you want to accomplish, you have a good idea of where you are heading and what it would take to get there. Once you figure out your time horizon, you can come to terms with how much of your investment can be put at risk. The closer your goal, the less you can afford to lose, so the focus should be more on preserving what you've made rather than on generating additional gains. The more time on your side, the more should be the tilt towards equity.
2) List what your already own.
Chances are you already have some investments. Now here is where you need to do some work. A successful portfolio is never thrown together haphazardly but constructed on a solid understanding of the components.
Can you explain how all your investments work together? Which are your core investments? Are you diversified? Do you have a lot of overlap? You must be able to answer those questions before you can see how (or even if) your portfolio fits your pattern.
To figure out exactly what you own, you could note down all your investments on a spreadsheet and calculate how much you have in various assets. Use Morningstar's Instant X-Ray to help you discover your portfolio’s asset mix, style-box breakdown, sector weightings, and so on and so forth.
You could weed out redundant investments. For instance, if you have three mid-cap funds, you probably don’t need all. But before you sell, ensure that you have held the units for at least a year to avoid short-term capital gains tax.
Check for 'holes' in your portfolio and fill them up. For instance, if you find all of your savings in fixed income instruments such as National Savings Certificate (NSC), Public Provident Fund (PPF), Employees Provident Fund (EPF) and bank deposits, ensure that future investments are channelised into equity to attain a balance.
Most importantly, ensure that your portfolio includes core holdings, those investments on which you're relying on most to help you meet your goals. Core investments should be the biggest part of your portfolio and should provide a foundation to build up upon.
3) Decide on an asset allocation.
The heavy lifting of any financial plan starts well before individual investment selection. In other words, sensible portfolio construction must commence with asset allocation. Some financial experts believe that determining your asset allocation is the most important decision that you'll make with respect to your investments - that it is even more important than the individual investments you buy.
So how do you decide how much should find its way into into cash, debt, and equity?
One rule of thumb is to use your age as a guide. For instance, if you're 33 years old, put 33% of your portfolio into cash and bonds and the rest into stocks. But like all thumb rules, it has its limitations. Some investors might find that figure conservative. Others might find that it's too aggressive for their particular goal.
For instance, a 23-year old girl who has just got her first job may be saving Rs 2,000 every month for her retirement. In that case, the entire amount can be invested in a diversified equity fund. However, another 23-year old may be focused only on the downpayment for a home within the span of two years. In that case, the money should go into a fixed deposit or a short-term debt fund.
Let’s go back to the second point. Once you figure out your asset allocation, take a look at your current portfolio. If that doesn't match the asset allocation you laid out in your blueprint, shift assets around to tailor the mix.
Importantly, the more time on your side, the greater the potential exposure to equity. So you can see the importance of having a blueprint at hand to make a decision.
