Managing Retail Investment Portfolio

How an individual can Manage Investment Portfolio

This post only focuses on investment portfolio management by an Individual. There are several theories that are being propounded for the management of an Investment Portfolio. Before we move ahead let us try to understand what a portfolio is and how a portfolio investment approach differs from individual security analysis.

What is a portfolio?

A portfolio is a collection of two or more assets. When you buy a stock of company X and one stock of company Y or may be a bond of company A, you have a portfolio to take care of. The several types or classes of assets could be bought and that too in differing proportions to be included in your portfolio.

How portfolio investment is different from individual security analysis?

For the purpose of portfolio analysis and management we cannot look into each security in isolation as we do for security analysis. In security analysis we try to study an individual stock or bond and look whether it is fit to invest into or what will be its growth trajectory in the time to come (may be in long-run or short run). Whereas in Portfolio Management we look into the effect of collection of securities into a portfolio, how well they behave when clubbed with each other and how the value of complete portfolio works out to be for e.g. if a portfolio has 3 stocks each from a different company and the total value of the portfolio is $30 (value of 3 stocks), now the fourth stock is added into the portfolio by paying $10 the minimum expected value of portfolio is $40 and it should grow with time, next year we expect the value (market value + returns attained) of the portfolio to be $50 but other things being constant, now the actual value (market value + returns attained) is $ 38 that means the portfolio has lost value of $ 2 after inclusion of the fourth stock and the fourth stock is not working well with the previous three stocks.

To be honest you need to understand your own needs and investing ability and the risk bearing capacity to manage your investments. No given theory or suggested methods could best suit an investor’s individual needs, only the individual can understand and make an educated effort  to actively manage the portfolio all the suggestions and theories could well act as a guideline and could be adopted in varying proportion to suit the individual or retail investor’s specific needs.

The retail investor though is advised to follow the principles of investing in equities as these principles are really helpful in protecting and maintaining the value of the holding but the limit of usability and the flexibility in the way of execution of each of these principle has to be devised by the retail investor. Before we start discussion about key points to remember in portfolio management, let us review key principles of portfolio theory –

1.       Principle of Diversification – Securities bought should be from different sectors and different industries and should be bought at different price ranges and at different intervals. Variations in types of securities i.e. debt, long-term debt, equity and might be inclusion of precious metal and property to diversify completely will not be wrong and is advised. In India though use of property as an investment asset is not considered as part of investment portfolio. The securities bought should have varying degree of correlation so if the prices of one security take the beating the prices of the other might go up to compensate for your loos.

 

2.       Mix of Debt & Equity – The investment portfolio should hold some debt (long-term or short-term) and equities. The proportion of the two (debt vs. equity) depends upon the individual’s needs.

 

3.       Value Investing (Long –term investing) – It is proposed and their exist sufficient evidence to suggest that long-term investing results into capital appreciation and capital gain, which is actually seek by most of the individual investors. Long-term holding may result into rise in market prices of the stock but it is not a guarantee that if you hold stocks long enough, may be 5-10 years the prices will rise sometimes there are economic situations or may be other scenarios where the stock at given point of time may be selling at a price lower than the purchase price. It is advisable that investments should be made for long-term and day-trading or short-term trading should be avoided as sufficient data will not be available to take short-term buying and selling decisions. The exercise becomes very risk and almost non-scientific in short-term.

 

4.       Risk and Return – The concept of Risk and return could not be avoided and had to be ardently followed. The ability to take risk and search for the higher returns has always deluded investors but any retail investor is advised to take a well-educated decision. Key point to remember is that there is no return without taking any risk and to generate returns the risk could not be avoided. The concept of proportional risk and return also is the matter of debate as the search for significant evidence to suggest that there exists certain securities for which equitable risk and return exists.

 

5.       No use of leverage – Money to be invested in a portfolio, especially in a stock portfolio should not be borrowed or funds invested should not have interest charges attached to it, in the hope that prospective returns from the investments are going to be higher than the attached cost of funds or interest charges.

 

6.       Do not try to time the market – Most of the new naïve investors make this mistake as they try to enter into the stock market when the market has a bull run or in other words the stock prices are soaring and indices are skyrocketing. These investors enter in the hope and in search of short-term profits or expectations are to make a windfall. They buy stocks when the prices are moving up or soaring with the expectation that prices will further go up and the investors on their recent purchases will be able to make an abnormal profit that will facilitate major incomes after offsetting any brokerage charges and tax liability.

 

Usually these naïve investors are not lucky and they fail to predict the stock market movement and they keep holding their investments in the hope of further rise in prices whereas the momentum is lost and the prices started to fall.

 

Steps in Portfolio Management

 

 



 

The above process of portfolio management has to be carried out actively by the investor and an investor has to be proactive in investing and associated decision making. Point to remember is that you are responsible for your own money and value of the assets, key objective being positive movement in the value of assets!

The 3 step process seems easy but it is actually very difficult to follow and implement.

Tips for Effective Portfolio Management

1.       Invest for long-run and try to generate maximum value both in terms of capital gains (positive changes in market price of the security) and dividend income as well as interest from debt securities received over the period of time.

2.       Try to diversify to the maximum, use your knowledge and do active research for diversification. Focus should be to avoid buying too many securities of the same type and from the same company or from different companies from the same industry.  Diversification tries to minimize risk and proper diversification helps in avoiding unsystematic or company or specific security related risk.

3.       Try to match risk return profile on your portfolio. Remember no returns without risk and you cannot maximize returns at a given level of risk. Risk profiling and matching the returns for a given level of risk is important and the investor has to select optimum level of risk and based upon level of risk, he should accept the returns.

4.       A natural tendency is to look at returns only or to study returns over a period of time and then decide whether to invest or not to invest but this is an inefficient practice and should be avoided. The more educated practice is to look at your capacity to invest and ability to depart with the invested amount, if your ability to lose money is less than try to invest in less risky assets such as bonds, fixed deposits, mutual funds or debentures and be ready to accept lower rate of returns. In other words look at risk first and then try to see most optimal level of returns available for the given level of risk.

5.       Portfolio churning or pruning of securities has to be carried out at regular interval. Churning ratio should not be very high, efforts should be made to select securities with strong fundamentals and good grounding within the industry and the economy so you do not have to change or buy & sell them often. Remember more transactions means high brokerage and may be associated tax to be paid as hardly in the globe, any frequent stock transactions are independent of brokerage and associated tax liability.

How to maximize your returns from the portfolio

Consider that all the principles and tips for safe investment are being followed and now is the time of selecting the assets and looking at how the securities are to be picked so most appropriate balance within the portfolio is achieved. The starting point is your investment objectives and ability to take risk and ability to depart with liquidity or the lock-in (time when you cannot take out the money out of the security) period suitable to your level of income or expected future level of income.

The discussion to follow focuses on maximizing the returns and how you can distribute your investments in different level of securities (based upon capitalization and associated risk) to maximize the associated returns from your portfolio. This strategy is just indicative and has to be customized as per an individual’s risk appetite and objectives.

The major assumptions for this indicative strategy are –

1.       Insurance policy for life and health are different and has been treated differently. Both term plans and endowment plans are to be considered separately and not to be considered as part of this investment strategy.

2.       Real Estate investments are different and could not be directly considered as part of the suggested investment strategy.

3.       Pension products or recurring deposits are not considered as they are the essentials and they are must to have in convenient proportions before setting off the proposed investment strategy.

The indicative strategy uses an investment value (initial outlay) of $100,000. To start we will try to create some safety net by investing 30% or $ 30,000 in debt securities or mutual funds dealing with debt or income funds. Next level of investment will be to put 20% money in equity linked mutual funds or growth funds, point to consider is that high risk funds investing in buyouts or Greenfield ventures should be avoided.

Out of remaining 50% or $50,000 we will invest $30,000 in highly capitalized well consolidated stocks of recognized corporation and would hold these stocks for long-term so as to generate value or capital appreciation.

30%+30%+20% = 80% is invested or $80,000 is invested and we are left with $20,000 to play with this is also the amount with which we would like to maximize our returns but catch is also risk will be increased. This 20% could be made less and even the above proportions are suggestive not watertight or specific and an investor can adjust these investment categories as per their comfort levels and needs.

The remaining 20% should be invested into small caps or upcoming companies that showcases potential for growth both in business and customer demand for its stock and product offerings in consumer market and has high difference in their Maximum Market Value and Minimum Market Value in last 52 weeks. These shares are to be bought and observed over the period of time and should be churned (bought and sold) every month and if price prospects on fortnightly observation seems favourable could be kept in the portfolio for a month to a quarter but long-term holding should be avoided as these stocks are potentially risky and the risk increases with the time period of holding.

Portfolio Pruning and churning (time frames)

The Portfolio pruning and churning are two differentiated activities to be carried out at different time intervals and to be evaluated as per the specific need of the specific portfolio. Churning is a major activity and could be forced by several factors such as economic conditions or may be change in the legal requirements or might be made compulsory due to changes in statutory requirements. Churning means to change a portfolio or to make evaluation about portfolio performance and see how the expected returns could be maximized. An individual could plan certain strategies to alter an entire portfolio as well could go ahead and change the weights of the securities (stocks, bonds and certificates etc.) or the types of investment vehicles (mutual funds – types, fixed deposits or corporate bonds. Even period of investment could also be altered and capital market or money market securities could be included or excluded as per the specific needs of an individual) or types of investments (debts vs. equity). In simple words the properties of the original portfolio could be changed and the newly emerged portfolio might not have any resemblance to the original one.

The pruning means not to make major alteration in the portfolio but to take out non-performing assets or underperforming assets or securities and replace them with potentially more profitable assets. The basic properties or the features of the portfolio are to be kept same only certain securities are to be replaced.  The process is quite similar to weeding and an individual has to make sure that after pruning the portfolio grows and all securities perform to the best level.

The Portfolio pruning process is an ever going process and has to be carried out at least once very fortnight or on continuous basis as the need arises. This is important to make sure your portfolio stays in shape and expected returns are not compromised. While pruning make sure the strict vigilance is kept over the penny stocks or small caps and they are replaced or kept under straight proportion (lower value) in relation to the total value or the worth of the portfolio.

The Portfolio churning could be done once a year and almost all securities has to undergo the process where a retail investor has to match the performance of the complete portfolio with the performance of the market as well as each of the security with other alternatives available in the specific industry (i.e. Steel, IT, Banking and Telecom) or the asset category (Mutual Funds, Money Market Securities or Stocks).

Some theorists propounds that FDs (auto renewal) or Large Caps should not be touched in short run and kept for longer periods as their value will rise and you will get magical returns… It is not recommended to keep any Asset or Asset Category to be kept unchecked. Though the advice is not to sell any asset if the prices are found extraordinarily high or low and replace them with something which might not be an exact match or the replacement for the asset you have sold. Recommended is to check and if financial sensibilities and indicators show that the financial asset is secured and still profitable then to keep it and if possible try to diversify the portfolio by buying or bringing in more assets or assets categories.

It has to be noted that more observant you are, more aware and vigilant you are, more secured will be your portfolio and higher will be the expected returns.

 

 

 



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