A QUESTION we have often been asked by individual investors is how they can set up and manage their own investment portfolios.
Successfully setting up and maintaining an investment portfolio requires a certain level of financial
literacy and solid research backing in order to know when to take appropriate investment decisions. It also requires discipline and abiding by a set investment policy.
People set up investment port-folios for different reasons. And depending on these, the way in which the portfolio is structured will differ. In this article, we will assume that one wants to set up a portfolio with a medium to long-term perspective (ie six months or more).
We also assume moderate risk appetite. To limit this article’s length, we will also give guidelines for a basic stock and money market-based portfolio (full-length article is available on http://www.adway.co.zw), but other asset classes can be incorporated into the investment mix. The following are the five basic steps involved:
Research has shown that this stage accounts for as much as 90% of the expected return from a portfolio. You should determine what portion of your portfolio will be allocated to stocks and to money market instruments. Generally, this is determined by comparing expected returns from the stock market to expected returns from the money market.
An important consideration at this point is whether or not one may require funds from the investment portfolio.
If funds may be required at short notice, avoid locking up money in long-dated money market instruments, or stocks (generally, the less liquid the investment, the higher its expected return, therefore there is a trade-off between having available funds and earning the highest returns).
A general guide where one may need to realise part of the portfolio for sustenance is to keep money market assets equivalent to about six months’ expenses.
Having decided to invest in particular asset classes, you need to select instruments to be included in each of these.
On the money market, you need to plan how much will be placed on call (to meet current expenditure), and how much will be put into fixed deposits.
Generally, longer dated investments yield more, but you want to plan your investments so that some of these will mature over 30, 60 and 90 days, for instance, to meet anticipated expenditure over these periods.
You also want to retain liquidity to allow shifting the portfolio weighting should the market tilt in favour of equities. Where interest rates are expected to decline going forward (like now), you may want to fix money for longer periods in order to benefit from the prevailing high yields.
For stocks, you need to determine which stocks are expected to perform well over your investment horizon. It is important to select a variety of counters to diversify risk, and a rule of thumb is not to exceed 20% weighting by cost in any one counter.
This rule can of course be varied; fewer counters raise the level of risk and potential returns while more counters reduce risk and potential returns.
A general misconception is that diversity requires investing in counters in unrelated sectors. Modern investment thinking calls for buying a wide range of counters, but focusing on sectors expected to do well in the near future.
One can always revise their sector mix over time as circumstances change.
Make the investments
Having structured the portfolio, the next step is to implement it. The current instability on the financial markets makes it important to firstly choose solid institutions through which to set up portfolios. For money market investments, if you are investing large amounts it may be possible to request the actual security being purchased.
For smaller investors, this may not be possible. Therefore, ensure that you invest with reputable financial institutions and that deal notes are received for monies invested. Verify the correctness of such deal notes. Shopping around for the best rates is a worthwhile exercise, but take into account the risk factor mentioned above.
For stock market purchases, request to have share certificates registered in your name and verify that this is done. All securities must be stored safely as they will be required when the investment matures, or when you decide to sell the investment.
You may alternatively use safe custody services offered by the financial institutions from which you purchase these securities, or by other financial institutions, lawyers or trustees.
It is important to keep track of what is going on in the various markets in which you are invested and specifically, in the counters
which you hold. Adway Investment Services (Pvt) Ltd offer a comprehensive research service which allows you to do this at a competitive cost.
When significant changes in fundamentals occur, it may be necessary to shift your asset allocation. Where changes are favourable for equities, determine which counters to add onto your portfolio, remembering the rules on diversity mentioned in the second point above.
If changes are adverse for equities, determine which of your stocks have the least expected gains and dispose of these. A common mistake is to keep on holding onto stocks “because I bought them at a higher cost than where they are trading now”.
The price at which you bought a share is irrelevant in making the decision to dispose of it. What is relevant is the expected gain from holding the stock.
The above steps consistently followed and complemented by sound investment advice, should result in market-related, or even market-beating returns.
While variations of the above are used in practice, these steps form the basis of every successful investment strategy.
It is important to note, particularly for stock market investments, that returns come over time, and patience will generally be rewarded. — Own Correspondent.