WHY and HOW to build a Portfolio?

Buidling a portoflio is similar to buying a house. You simply use a top-down approach. First, you decide, what kind of location you want to live in and then you decide what kind of house you want to live in depending on how much money you have to spend. Similarly, buidling a portfolio, you decide what phase of market cycle your in, and what kind of investment you want o be invested. It sounds simple, and when applied correctly, you can reap great returns.

Why build a portfolio?

This is the first question which comes up in the mind of most investors. Any novice investor,wants to buy one stock and get rich quick. However, an experienced investor will diversify his investments across different investments to minimize risk as different investments/stocks grow at different pace to each other during bull market and understands that during a bear cycle correlation in stocks in downturn is equal to 1 i.e. they go down together, and it’s close to having to no edge in the market. Having multiple investments like stocks and bonds in a portfolio helps to improve the return of an investor as he or she can position his/her portfolio in a position of strength during different kind of market conditions.

How to build a portfolio?

First foremost, it’s important to understand what phase of the market we are in. Is it a bull or bear or is it rangebound? During bull markets, stocks usually outperform bonds. But which stocks to pick, here is where relative strength comes into play. During different stages of market cycle, some sectors outperform the other and some stocks withing those sectors outperform the others. In terms of determining which sector is strong, it can be determined by looking at the ETF’s of each sector. Some of the common one’s that I follow are:  XLU (SPDR-Utilities), XLE (SPDR-energy) , XLF (SPDR-Financial), XLV (Healthcare), XLI (Industrial). Secondly, for investors who are more conservative can look for large cap names which have a history of paying dividends, for investors who are willing to take on more risk, you can indulge in small caps within those sectors and determine which one has the highest potential for growth. Thirdly, if the market is in a bear cycle, shorting stocks is a viable options too, however, once again depending on which sector is weaker across the board, look for stocks which have low short interest (the reason being there is lesser likelihood of a short squeeze as compared to stocks which have high short interest). The other option during bear markets are investing in bonds (which is altogether a huge topic in intself). 

Always understand what is the risk/reward and risk what your willing to loose. If you can’t sleep at night because of fear of investing or can’t pay your next mortgage if your investments go down, I would recommend you to reevaluate and check if your in the right investment.

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