Building an investment portfolio can seem intimidating to those who are just beginning their investment journey. It can be challenging to set aside sufficient funds each month, while also budgeting for various expenses such as rent, equated monthly instalments (EMIs) for vehicles, and other obligations. However, the earlier you begin investing, the more time there is for your portfolio to mature and grow.
Smart investing takes into account your current expenses while ensuring that you can plan for your short-term and long-term goals. The most important aspect of building a portfolio is to balance growth opportunities with risks. The trick lies in understanding your own risk appetite while building a diversified portfolio.
Selecting investments and diversifying your portfolio complement each other or they look similar at times. You should choose investments diligently if you want to diversify your portfolio well. If you want to diversify your portfolio you should pick investments judiciously.
Warren Buffet said, "I will tell you how to become rich. Close the doors. Be fearful when others are greedy. Be greedy when others are fearful."
These famous lines of the two investment gurus aptly reflect the importance of carefully choosing your investment and its timing to gain and be safe.
Criteria to Choose Investments
Answer the following questions before you sit down to pick your investments. What is your investment horizon? What returns are you seeking to achieve? What amount of risk are you able to take? What amount of funds are available for you to invest? What are the goals of these investments? The answers will guide you toward making intelligent investment decisions.
You may start with the breakdown of your proposed investments between cash, fixed-income securities, and shares (equity). The breakdown of your asset allocation ultimately depends on your risk tolerance and expectation of the returns. A conservative investor may opt to hold 80% of his portfolio in fixed-income and 20% in equity. The reverse could be true for an aggressive investor, while a balanced investor might follow a 50-50 combination.
Let us take a look at the topic ‘how to pick your investments’ from these three angles - underlying factors, investment strategies, and crucial parameters. This piece is not just about picking shares but about picking the right instruments from debt and/or equity, that suit your risk profile and goals.
The attributes or the underlying factors of each investment vehicle need to be analyzed thoroughly as part of your investment filtering process. Some important factors that need to be considered are:
You should evaluate the investments from the angle of return and growth in the short-term and long-term horizons to help you take an ideal decision. To put it in another way, this is a growth vs income option - short term is income and long term is growth.
You should have a clear-cut financial goal for your investments. In other words, life milestones like wanting to build a corpus for a child’s education, buying a house, planning for retirement, etc. are examples of your goals.
No doubt that cash is the most liquid investment but it comes with no return or growth, rather it depreciates if held for long period. Some assets like real estate may provide higher returns, but is a most illiquid assets. Clarity on your goals and horizon will help you make decisions on investments based on liquidity.
Arguably the most critical factor. The risk and return go together. The more the risk, the more the return and vice-versa. The choice of investment should match your risk profile. A conservative investor would not be comfortable investing all or a large portion of his/her money in high-risk investment options.
Certain types of investments are tax-efficient. However, investments in such instruments should be a part of your overall financial planning and not the ultimate purpose of your investment. What you count as your return should be your post-tax return.
Investing your money without an investment strategy is like a sports team going into a game without a game plan. Having an investment strategy will help you discard many potential investments that may result in loss or that are not ideal for achieving your goal.
It is also important to quantitatively figure out your goal. Simply stating that you want to make money or maximize your wealth is not an investment strategy but something like having a corpus of a certain amount to retire by a certain age is a specific and quantitative investment strategy.
You must decide what type of investment you need to make to achieve your financial and life goal. Here are some of them:
- Value Investing
The principle behind this investment strategy ‘ buy and hold’ made popular by Warren Buffet is - to buy shares that are cheaper than they should be and hold them for a few years. Warren Buffet has significantly outperformed the market thanks mainly to the effect of the power of compounding by holding shares for long period.
- Income Investing
Income investing involves buying securities that generally pay out dividends and return regular fixed income. Bonds, debentures, bank and money market deposits are the best-known examples of fixed income security, but dividend-paying shares, exchange-traded funds (ETFs), mutual funds, and indexes are other forms of income investments though they are not fixed-income. There are many fixed-income traditional and innovative investments that provide a reliable income stream with minimal risk. For example, Grip has an innovative investment product in the form of leasing investment that can be made in amounts that are affordable to each investor but provide higher returns than many other fixed-income instruments.
- Growth Investing
Growth investors focus on companies that generate above-average growth, through revenues and profits, even if the share price appears expensive in terms of metrics such as price-to-earnings or price-to-book ratios. Peter Lynch is famous for growth investing which involves investing in smaller companies that have a high potential for growth and emerging markets.
- Small-Cap Investing
As the name suggests, small-cap investing involves purchasing shares of small companies with smaller market capitalisation. The prices of small-cap shares will be cheap than they should be because they go unnoticed. Small-cap investing is meant for experienced share investors because of its volatile nature and the difficulty in trading.
- Socially Responsible Investing
Also known as environment, social and corporate governance (ESG) and Impact Investing though not strictly the same, this is about investment in socially responsible companies that make a profit. In the current times, investors and the general public expect companies to maintain some social conscience. SRI is one path to seeking returns that benefit everyone. India is the first country in the world that has made CSR mandatory for companies that have crossed a certain threshold.
The purpose of an investment portfolio is to ensure your financial stability and independence. It allows you to plan for emergencies, ensure regular income, and provide you with the financial freedom to meet your expenses. By setting aside adequate savings each month, we also gain financial discipline and the self-confidence for making judicious decisions regarding finances and future planning.