Building an investment portfolio from scratch

How to start building an investment portfolio from scratch? 

This looks like a logical question for beginners, right? But even experienced investors can take clues from here. 

People who have not built their investment portfolio till date, how they can go about it?

These are people who are busy doing 9-6 job.

They do not know much about stocks, leave aside reading financial reports of companies. Researching stocks is not their domain.

Majority are not able to build their investment portfolio due to these limitations. 

I personally feel that, to start with, even if one knows nothing about stocks, building portfolio is possible. How?

This is what we will discuss in this article.

But isn’t this approach risky?

Yes it is risky. But in stock investing, taking the first step is essential. 

One must enter the deep waters by self to learn swimming, right?

Similarly, one cannot expect to learn everything, and then buy the first stock.

Here the learning happens with experience. This is the only way. 

But the way forward is not to be feared about. It is a systematic learning. We will try to move gradually with care.

Following objectives will drive our way forward.

  • Buying Equity will be priority. 
  • Minimising risk of loss will also be a priority.
  • Learning while investing will be the goal. 

This approach will make building an investment portfolio from scratch less risky and more rewarding. 

How it will be rewarding?

The purpose of portfolio building will make it rewarding. What is the purpose?

Wealth Creation is the purpose…

Do not worry, I am not going to give lecture about wealth creation here. 

I will just give you a perspective, based on which building an investment portfolio will look more like a mission of life than a task. 

Let me ask you a question here…

How much is your Net Worth (size of wealth)?

Do not count your residence, EPF, car etc here. 

What you can count are as below:

  • Constituents of Investment Portfolio:
    1. Savings & deposits,
    2. Stocks,
    3. Mutual funds,
    4. Gold coins,
    5. Property put on rent etc.
  • Total debt (count as negative):
    • Home Loan.
    • Car Loan.
    • Personal Loan.
    • Credit Card debt etc.

Net Worth = Investment portfolio size minus Debt.

If this value is less than 10% of your annual income (CTC), you need to reconsider building your investment portfolio. 

The bigger is the size of this portfolio (compared to your annual income), the wealthier you are. 

Building an investment portfolio from scratch -1.1

What is shown in the above infographics?

In 5 years, the person has to do the catch-up with his/her CTC.

What do I mean?

Suppose in year 1, ones net worth was 10% of CTC. 

By the fifth year, ones net worth must become 100% of CTC. 

This should be the goal of a person who is building investment portfolio from scratch. 

The idea is to buy stocks, funds, deposits, gold, property, keep-cash etc, with the overall purpose of wealth building. 

Where to start?

First decide how much of savings your can allocate to “net worth building”.

What does it mean?

Suppose your monthly savings is say Rs.10,000.

How much of Rs.10,000 you can allocate for net worth building? 

Some might say that as Rs.10K is savings, lets allocate 100%. But this will be a mistake. 

A family needs savings to take care of other needs/exigencies of life. 

Hence, as a rule of thumb, initially allocate not more than 25% of your savings towards net worth building

Let the process of “building investment portfolio from scratch”, start from these savings.

With passage of time, you will be able to take a better view on, whether to increase the 25% contribution or keep it the same. 

Difference between “other savings” and “savings allocated for net worth building”…

The savings allocated for net worth building is like a one way traffic. 

The flow of money is only one way, from your wallet to your investment portfolio. 

Flow of money from portfolio to wallet should not happen.

Yes, this is most important. The money allocated to buy stocks, mutual funds, gold property, etc should not be used any where else. 

This money should be used to buy only investments. 

Does this mean than, the investors shall never liquidate ones holding in stocks, funds etc? No.

Investor is free to do the profit booking. But the liquid money so generated, must be immediately re-locked in another asset. 

Idea is, not to sell assets to buy a car… 🙂

What if the savings contribution is too low?

Do not worry.

Here important is to start building an investment portfolio.

The quantum or speed of growth is not as important. 

Even if the contribution is of just Rs.500 per month, use it. 

Use this money to buy mutual fund units through SIP route. 

Where to invest money?

Here important is to make two consideration before investing:

  1. Investor is new.
  2. Investor wants to buy equity.

New investor means, know-how of equity is limited. Hence direct investing in stocks shall be avoided.

So what can be done?

Best will be to start buying either of the two:

  • Index linked ETF.
  • Index linked Mutual Funds. 

Moreover, it is also important not to buy the above when market is bullish. 

How to know if the market is bullish or not?

See the NAV chart for last 1 year. If the price trend is only up, it means the market is bullish. 

Building an investment portfolio from scratch -2
Fig.1 – Bullish Market – Avoid

The above chart shows the situation in year 2017, where the price trend was predominantly upwards. 

In such a market scenario, there are more chances of buying funds which are overvalued. 

So the strategy should be to let the market cool down first. 

The market which is showing signs of cooling down will look like this:

Building an investment portfolio from scratch -3
Fig.2 – Bearish Market – Start Here

The above two figures are representative of a bullish market and bearish market. 

Unlike popular belief, it is the bearish market which is more apt to start building an investment portfolio from scratch. 

Today we are in Oct’18, where the stock market is looking to take a bearish turn. 

Start investing now. 

Shall we go all-out and buy mutual funds now?

For a beginner, who is just starting to build a portfolio, gradual start will be better. 

The market is going to drift towards its bottom in next 6-8 months time. 

But this is also true that it is almost impossible to predict what will be market bottom and when it will come. 

So it is better to follow the stock market. How?

Systematic purchase of units (index funds, index ETF’s) every month for next 6-8 months. 

The lower the market goes, more units will be purchased. 

This is great for the investor. How?

Rule says, buy as much as possible when market is falling. Why? Because when market revives, every extra unit purchased will add to the profit. 

So what is the strategy? Start a SIP in Index fund. Also, keep buying Index ETF every month.

Target should be to see the falling index and buy more.

How to invest when market is bullish?

Buying equity when market is bearish is a good strategy. 

Not-buying equity when market is bullish is also a good strategy.

So what a common man should do during bullish market?

Look for debt based options. 

Which are debt based options?

  • Savings account. 
  • Fixed Deposits. 
  • Debt based mutual funds. 
  • Bonds etc.

The idea is to keep investing in risk free options when market is bullish. Why to avoid equity?

Because there is a high chance of picking equity at overvalued price levels during bullish market.

Hence instead of investing, during these times, its better to “accumulate savings” by investing in debt based options.

The below infographic will show clearly, how to act when market is bullish and bearish.

Building an investment portfolio from scratch -4

Conclusion…

How a common man can start building an investment portfolio from scratch?

Who is a common man?

  • Person in job.
  • Has little know-how of equity.
  • Has limited time to give to investment.

Such investors must preferably invest in auto pilot mode (SIP).

Why to invest in first place? For long term wealth creation. 

If the person is interested to devote slightly more time to built his/her investment portfolio, follow a simple rule. 

  • Buy Equity – when market is bearish.
  • Buy Debt – when market is bullish.

What to do with the accumulated debt and equity?

During bearish market, sell debt to buy more equity. 

What to do with equity? Nothing. Just go on accumulating it. 

If at all you decide to sell, use the liquidated money to buy more of debt/equity in times to come. 

This is one of the most simplistic strategy of building investment portfolio from scratch. 

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