Knowing how to build a stock portfolio is one thing, but understanding the different aspects of building a profitable portfolio in the long run, is another. In this article, new investors will learn what a stock portfolio is, how many stocks are ideal for a portfolio, why diversification is essential for new investors and the different types of companies you can hold.
What is a Stock Portfolio?
A stock portfolio is a collection of stocks that an investor has invested in the hopes of profiting in the long run. Most investors will diversify their portfolio, putting together stocks from various sectors to manage potential risks. For example, if the share price of a travel company takes a hit, then the loss may be mitigated by the rise in a tech company’s shares.
How Many Stocks Should You Have in Your Portfolio?
The number of stocks you hold in a portfolio is a personal choice and is generally based on an individual’s current circumstances. These include the holding time, time to conduct research, knowledge, and targets.
Most people believe that between 20 to 30 stocks are ideal for a portfolio to be well-diversified, but as mentioned previously, it depends on different factors. For example, Warren Buffett once said that “diversification is protection against ignorance. It makes little sense if you know what you are doing.” However, he also stated that there is nothing wrong with diversification if you have little experience or don’t feel you know how to analyse a company.
So, it’s essential to understand your own circumstances and limitations when building a portfolio and what you’re are looking to achieve. For example, if your time is limited and you are new to investing, then ensure you diversify, or if you have a lot of time and are an experienced investor, you can concentrate on a smaller amount of stocks.
What types of stocks to include in a portfolio?
There are various stock categories available, and companies may fall under more than one or two categories, for that matter. It is also another way of diversifying your portfolio to protect against downside risk.
As the name suggests, growth companies are expected to grow rapidly, faster than the rest of the market. As a result, these stocks carry greater risk as if the company’s growth does not match the market’s expectations, it is more likely that the share price will fall.
Most growth companies will also not pay out dividends to shareholders, preferring to reinvest in the business to accelerate growth further. Here is our analyst’s view on the best growth stocks to buy in 2022.
Income stocks generate a steady income via dividends. They are typically less volatile and offer higher dividend yields, higher than any benchmark average. When it comes to companies, think of UK dividend stocks such as M&G, Evraz, and Vodafone or US dividend companies such as Universal and IBM. Reliable names of stable companies.
Cyclical stocks move in business cycles, tracking the overall quality of the market. So, for example, during an economic boom, a company such as UK online estate agent, Purplebricks, will do well as people are more likely to buy houses when the economy is doing well. The same goes for car manufacturers, airlines, construction companies and banks.
One practice that investors often use is to buy cyclical stocks when the economy is suffering, try and purchase the stock at a low price, and then look to sell the shares at a higher price once the economy has recovered.
Speculative stocks are companies where the future is unknown. They will be volatile, usually cheap and have little information available when it comes to earnings. These are risky investments.
However, investors are attracted to speculative stocks due to the potential for lucrative returns and low prices. When investing in speculative stocks, you are essentially making a bet on the company’s future. It may be that you believe in its product, an expansion or a new direction that the firm is taking.
Consider Your Risk-to-Reward Profile
How much you risk per investment will depend on your finances and your risk tolerance. It may also depend on your confidence in the company itself.
If you don’t have a large amount of money available but want to diversify your portfolio, your risk per position will be considerably smaller than if you were investing in only a few companies.
On the other hand, you may not want to risk a large amount of money on a stock because the potential reward is not significant enough to take up a large portion of your portfolio.
If you have a low-risk tolerance, it may be better to consider stable companies that provide a steady dividend stream and less volatility.
Identify Your Investing Goals
To identify your investing goals, you first have to consider why you are investing in the first place.
Is it to create a separate, steady revenue stream? For long term growth? Or retirement?
Whatever the reason, it will impact your goals. For example, if you want to invest so that you have money to sit on when you retire, then it may be beneficial to invest in a retirement fund.
If long term growth is your goal, then high dividend-yielding companies will be more beneficial. However, regardless of your target(s), investing in stocks is a fantastic way of growing cash over time. There will, of course, be fluctuations in the short term, but if you do enough due diligence and manage your risk effectively, it can pay off over time.
Diversify Your Portfolio
While Warren Buffett’s views on diversification are not favourable for experienced, knowledgeable investors, we have to consider that most readers will be new to investing. Therefore, we believe diversification will be a vital tool in your arsenal.
Firstly it will help you to manage the volatility. For example, if one sector has been impacted by a recent political shift, it may result in the stock/stocks you hold in that sector becoming volatile with significant price moves. Being diversified will protect against this as you will have less money in that one stock, and other sectors may be experiencing a boom.
To that note, and for much the same reasons, it also helps to manage risk. Your funds won’t be concentrated on a few stocks. The danger is that if you only hold a few companies in your portfolio and one sees a significant downturn, your finances will be impacted more severely.
While diversification is an excellent trait to take on for an inexperienced investor, each stock you invest in must come on the back of thorough research. This is a vital factor in helping you make a decision on a company, and also, if you do invest, it will give you confidence if the stock takes a dip at any point.
The same applies to risk management also.
The market will go through periods of ups and downs; it’s just part of being an investor, but if you cover every base and make well-informed decisions, you will give yourself a solid base to achieve your investing goals.