Five guidelines for building a stock portfolio

SO, YOU are ready to supercharge your savings by diving into the stock market. Kudos on taking your first leap to secure your financial future and boost your retirement funds.

But how exactly do you begin to build your stock portfolio? Are growth stocks the way to go, or should you focus on reliable blue-chip stocks that pay dividends? Dividend stocks can provide you with a steady stream of passive income to supplement the income from your job. But do not expect too much capital growth.

You also do not have to choose between growth and dividends. You could have a mixture of growth, blue-chip and dividend stocks to enjoy the benefits of each type of stock.

As you can tell, there is no one-size-fits-all answer since everyone has their own unique approach to selecting stocks. Still, let us simplify things. Here are five tips to kickstart the creation of your investment portfolio.

Your investment objectives and risk tolerance

Before diving into the stock market, take a moment for a quick self-assessment. Start by clarifying your investment goals. Are you just starting out and looking to boost your portfolio’s value? Or are you nearing retirement and seeking steady income from your stocks?

Once you have defined your objectives, it is easier to tailor your portfolio accordingly and decide which stocks to include.

Assess your risk tolerance. If wild market swings make you uneasy, steer clear of volatile growth stocks. Instead, opt for stable blue-chip choices such as CapitaLand Investment or Singapore Exchange for a more peaceful investment experience.

These stalwarts have been through different economic cycles, and their experienced management teams should enable you to enjoy a good night’s sleep.

Writing down your investment goals and understanding your tolerance for risk are key to crafting a portfolio that suits you best.

Ensure adequate industry diversification

To ensure that your investment portfolio is well-rounded, it is crucial to diversify across different industries. Relying solely on one or a few sectors can leave your portfolio vulnerable to market downturns or unexpected events, potentially leading to significant losses.

For instance, imagine if you were to invest in DBS, UOB and OCBC. While it might seem like you are diversifying by purchasing three stocks, the trio are in the banking industry and offer limited sector diversification.

To address this, you have two options. One, consider investing in conglomerates such as Berkshire Hathaway, Haw Par Corporation or Boustead Singapore that operate across a wide range of sectors. These conglomerates allow you to gain exposure to disparate industries in one fell swoop.

Two, build a portfolio with a mix of stocks from various industries such as banking, telecommunications, industrials, technology, retail and real estate, among others. This approach ensures broader diversification and reduces the risk associated with industry-specific downturns.

Do not put all your eggs in one region

In addition to diversifying across industries, it is vital to spread your investments across different regions or countries. Many Singapore investors tend to focus solely on local stocks, a phenomenon called home bias. Stocks such as Far East Hospitality Trust, Japan Foods and Genting Singapore operate primarily in Singapore.

To counter this local bias, consider investing in companies with international exposure. Look for global giants such as Kimberly-Clark, Coca-Cola or McDonald’s which have a presence in multiple countries.

Even on the local exchange, you will find companies with diverse geographic operations. Take iFast Corporation, a fintech firm with operations spanning Singapore, Malaysia, Hong Kong, China and the UK; or Micro-Mechanics (Holdings), which serves markets in China, US and Malaysia.

By diversifying across countries, you can reduce the risk associated with a single region’s economic performance.

How many positions?

Next, there is the question of the number of stocks in your portfolio. There is no “right” answer to this question as it depends on your investment style. Typically, a concentrated portfolio consists of five to eight stock positions, while a well-diversified one can range from 30 to 100 positions.

Consider how much time and effort you are willing to invest in monitoring your investments. Large, established blue-chip stocks often require minimal oversight. However, it is wise to give extra attention to fast-growing small or mid-sized companies.

If you find yourself spending excessive time monitoring your stocks, consider reducing the number of positions or including more low-maintenance stocks.

How large should each position be?

Finally, there is the question of the size of each stock position in your portfolio, also known as position sizing. Again, this topic is complex as there is no one-size-fits-all solution.

A simple guideline is to evaluate the risk-reward ratio of each stock. Consider allocating a larger portion of your portfolio to lower risk stocks. However, if a business operates in a volatile industry or faces uncertainty, it is wise to limit your exposure with a smaller position. This risk-reward approach helps you decide how much capital to allocate to each position.

Keep in mind that you can adjust your allocation as your confidence in a stock grows. Similarly, if a stock encounters challenges, you can reduce your position to minimise losses.

Here is another tip: always keep some cash on hand. Market downturns can present opportunities to buy your favourite stocks at discounted prices. These situations also allow you to increase your stake in stocks you are confident about.

Sometimes, a position can grow too large as a stock’s price climbs steadily. While it is a nice problem to have, consider trimming the position if it becomes too large and makes you uncomfortable. This rebalancing move helps to re-allocate funds to other promising stocks.

Remember, managing position sizes is an ongoing task. Regularly assess whether each position aligns with your investment goals and risk tolerance. Think of it as a mental check to ensure that each position offers the risk-reward balance you are aiming for.

Get smart: monitor and review

Remember to monitor your portfolio’s performance regularly and ensure that it still matches your investment goals. Performing an annual or semi-annual portfolio review keeps you informed about your stocks and allows for adjustments if necessary.

The writer owns shares of DBS, Singapore Exchange, iFast Corporation, Boustead Singapore and Micro-Mechanics (Holdings). He is portfolio manager of The Smart Investor, a website that aims to help people invest smartly by providing investor education, stock commentary and market coverage.