Building a successful stock investment portfolio can mean the difference between major wealth, mediocre returns, or significant losses. The question is, how do you create a stock portfolio successfully?
No, it's not a game only to be played by wealthy individuals, investment experts, or analytical wizards. It's a game to be played by everyone, even those who don't know how or don't have much money to begin with.
All it takes is understanding a few common concepts, knowing what to look for, and letting your investments sit for the long term, growing to wild success. Here's how to create a stock portfolio, regardless of your current circumstances.
Ingredients To Building A Winning Investment Portfolio
Before we get into the steps of how to build a stock portfolio successfully, you need to understand a few crucial concepts to follow from the start of your investment journey.
These concepts will help eliminate common mistakes, avoid potential losses, hedge against volatile markets, and allow compound interest to work it's magic!
Before you invest in any one company, you better be sure you've done your basic research. I'm not talking about making a visit to the headquarters and speaking to the CEO (although it wouldn't hurt), but what I am talking about is analyzing the fundamentals of a company to understand how stable they are.
This includes answering common questions like:
- Does the company have a competitive advantage?
- Do you personally use the product or service? Do you like the product or service?
- Does the company have strong financials? Examples of strong financials may include little debt, high amounts of cash, growing revenue, and increasing earnings per share (EPS).
- What is the company's market capitalization?
- Can you confidently confirm that you will be a long term investor in this company for the next ten years?
These are just a few to start with. The objective of doing your research is to narrow down your list of investments to a select few companies to dig deeper and invest in for the long run.
See more about how to find great companies to invest in here.
Successful investors regularly add money to their portfolio. The easiest way to do this is to set up automatic transfers every week, bi-weekly, or monthly to have a set amount of money added to your account. Adding to your portfolio also means revisiting your portfolio, as you add cash, and investing that money into the companies that you have hand-selected.
Some brokerage accounts will allow you to set up automatic investments. If you want to build your positions of a particular company, you can have your brokerage invest money into that company on autopilot, much like your automatic transfers.
Consistency is taking automation a step further. It means sticking to your plan for a long time. A long term investor plans to leave their money invested for at least ten years. As quoted by Warren Buffett:
“If you aren't willing to own a stock for ten years, don't even think about owning it for ten minutes.”Warren Buffett
It also means sticking to a process that doesn't deviate from these guidelines outlined in this article. If a company has a great product that you love, but their financials are too risky for you liking, then don't invest in it (for example). Stick to the process!
Logic, Not Emotion
Investing in stocks, ironically, is an emotional process that requires logic alone to make investment decisions. The second you let your emotions take charge of your investment decisions, you can bet your returns will be less than mediocre, to say the least.
What does it mean to make investment decisions based on logic? It means sticking to the facts. Does the company have strong financials, do they have a strong product, inspiring culture, visionary leadership, brand equity, etc.? If so, then they may be a great investment opportunity, even if it's during a global pandemic, despite what your emotions are telling you!
The fact is, every stock market decline, recession, and depression have recovered to its original market values and later exceeded its former highs. Long term investors know this and don't let short term market volatility lock in their losses by selling an excellent long term investment.
Diversification is a time-tested investing strategy that lowers your risk and hedges against potential losses. If one company is having a terrible quarter and you're losing money, another company that's in your portfolio, perhaps in a different market or sector, is likely to be having its best quarter yet.
You've heard the term “don't put all your eggs in one basket,” and diversification is simply a term for that phrase. The goal is to diversify your portfolio in such a way that it aligns with your desired risk tolerance.
A good rule of thumb is diversifying your portfolio among at least ten individual stocks and no more than 30 stocks (give or take). Why? Once you start spreading yourself too thin among hundreds of companies, your results will be average at it's best.
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Too many stocks don't let you take advantage of significant growth in some companies because you're spread so thin among so many businesses that a major increase in one company equals a small percentage of your overall portfolio.
Too few stocks become too risky because one company can sway your portfolio value by a lot if they have a terrible quarter. There is a sweet spot that investors can stay diversified while still not spreading themselves too thin, and that tends to be anywhere between 10 to 30 different stocks.
The more companies you have, the less risky and less growth potential. The fewer companies you have, the riskier but, the more growth potential you have. You be the judge.
5 Steps To Build A Successful Stock Portfolio
Building a portfolio of great stocks is an exciting venture! If you follow the time tested strategies discussed above, you're primed to build a long-term, successful investment portfolio. So, how do you start? Below are five steps to follow to build your own customized stock portfolio from scratch.
1. Growth, Value, Blend or Income?
There are four main types of investment portfolios. Each type aims at investing in companies with it's respective investment objective. The four main portfolio types are:
- Growth: Invest in companies that have significant growth opportunities. This usually means in small-cap companies, or, companies whose market cap is between $2 billion and $10 billion.
- Value: Value investors seek to invest in companies whose current value appears lower than their intrinsic value. In other words, value investors seek to find companies that appear to be on sale.
- Blend: This portfolio includes a mix of growth and value investments, and is perhaps the more popular strategy among the four.
- Income: Income portfolios seek to invest in companies that provide fixed income, or, regular streams of income called dividends. People seeking to invest in a portfolio of companies that pay dividends are usually closer to retirement and wish to turn their hard-earned money into regular cash flow.
The first step in building your customized portfolio is simple. What kind of portfolio do you want to aim to build? This will also determine the types of companies you choose to invest in.
As for me, I tend to seek companies with major growth, while hedging my portfolio against major losses by including some well-established companies with a history of success. You could consider this to be a blend portfolio, with a higher focus on growth companies.
2. Build A Shortlist
Next, you need to narrow down your investment choices to companies that may be potential investments. There are thousands of publicly traded companies, and we want to narrow this down to say 50 companies to choose from.
Using the strategies listed above, you can use stock screeners with your brokerage account to list companies that meet your desired characteristics.
3. Begin With Well Established Stocks
When starting your portfolio, it's wise to make sure your first couple of companies are either well-established companies like Apple, Amazon, Google, Facebook, or a market index ETF like the S&P 500.
This helps you lower your initial risk by diversifying and/or investing in companies whose chances of complete loss are slim to none. We'd hate to make our first investment, yet to find out they've gone bankrupt a month later.
Once you've added a couple of initial investments to set the foundation, begin following the processes laid out in this article to find other great investments to start adding to your portfolio.
4. Add To Your Positions Regularly
As your portfolio builds up a diversified list of great investments, be sure to continue adding to those positions regularly. How do you choose which companies to add money to? When it all comes down to it, you can use one of the following strategies:
- Pyramiding: Adding more money to positions that are already on winning trends. Companies with fast growth that keep reaching new price highs are likely to continue doing so – statistically speaking – for a long time to come.
- The rule of three: Pick your top three investments at that time, and split your cash up among those three companies.
- Buy the dip: If a company happens to have a down week, take advantage and buy while prices are low. You've already done the fundamental research for that company, so you can invest with confidence in the long run, even if its a down week.
- Play favorites: Simply pick your favorite company that week and invest more in that position.
5. Stay Updated On Company News & Events
Keeping tabs on company news and events is important. The easiest way to do this is to simply visit the investor relations page of the company website, and subscribing to company news and events alerts.
While we're long-term investors, it's also possible that one of your new investments takes a significant turn on their strategy that no longer aligns with your investment strategy. If this is the case, you'll want to be informed to make better decisions such as: not adding more money to the position, adding more money to the position, or merely letting that position stay put for a while. Ultimately, we want to determine if they still meet your investment qualifications.
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