11 Rules For Building Your Own Stock Portfolio

When it comes to building your own stock portfolio, you’d be forgiven to put it in the too hard basket. That’s often how the finance world works. Overload people with complex information so they outsource it to an expert to do it for you.

But building your own stock portfolio isn’t hard. If you want to move away from speculating on a few stocks you were told about to creating a stock portfolio that produces a result, here are my 11 rules investors need to follow. 

 

NB. The information on this page is not advice. It’s information based on my experience and your results may differ. Please seek advice from a professional before investing in stocks. 

Rule # 1 Know What The Company Does

Time and time again I see people buy into stocks that they have no idea about. They don’t know what the company does nor do they know how they make money.

This is an essential concept as buying shares means that you are a part owner of a company. So you need to think like an owner.

If you don’t understand what the business does or how it makes money, how can you weigh up the decisions by management?

A great example is Amazon. Everyone know that they sell a range of products online. But did you know that in 2017 for every $1 Amazon generated in sales, the company only held 2c?

Yep, you read the correctly. Amazon have massive expense in the business.

From knowing this piece of information, you know that volume is vital! Any event or decision that compromises on the volume of sales to Amazon will have a drastic impact on their profit margin.

 

Rule # 2 You Only Need 5 to 10 Stocks in Your Portfolio

When building our own portfolio, we think that we need to acquire a mass number of shares. I mean the fund managers do it, so it must be the right way to go.

In actual fact, you can build a powerful portfolio by owning only 5 to 10 stocks. I’ve spoken to countless people that have their own portfolio with 20 or more stocks.

That’s just insane! At that level you are operating your own managed fund and should consider having a fund manager invest it.

The reason behind this is that you need to be on top of every single stock that you own. You want to keep up to date with key pieces of information around reporting season, how it responds to market conditions as well as the future out look for the company.

Having 10 stocks can allow you to be diversified enough to achieve long term goals as well as having scope for some of the more speculative stocks.

Rule # 3 Always Have Cash

Sometimes the market creates great buying opportunities. It can just be a knee jerk reaction to economic news that sends stocks on a free fall.

This is where you want to have cash to take advantage of the short term mis-pricing opportunity and buy a stock for a bargain price!

 

Rule # 4 Have a Wish List

This is straight from the Buffett playbook. He doesn’t get up each morning to try and find what might be on sale. He has a list of stocks that he has analysed and also notes what price point he want to buy in.

This allows you to make more sound investment decisions and ensures that you aren’t getting caught up in market hype.

 

Rule # 5 Expect a Downturn

 

From 1945 to 2019, they have been 79 occasions where the stock market decreased by 10%. That’s 79 times in 75 years meaning that this event happens almost yearly.

And every time it does occur, you can bet that the media will blow things out of proportion and make it seem like the end of the world!

In that same time period, the market has decreased by 10%-20% on 28 occasions. That means this will happen every 2-3 years.

Downturns in the market are inevitable, yet each one is portrayed as the end of the economic world as we know it.

Here are some formal definitions of key downturn terms that you will hear often.

 

Pullback – This refers to when the market declines by 5%+ from a recent high.

 

Correction – This means that the market has fallen by at least 10% from recent highs

 

Bear Market – A 20% or greater increase is what actually defines a bear market. It also refers to something that is sustained for a few months.

 

Rule # 6 Don’t Get Emotional

You have to develop the ability to love a stock one day and hate it the next. Okay, I know those two are emotions but they are referred to in the most robotic and robust way possible.

I’ve seen it time and time again where people are emotionally in love with the stock. Whether it’s because the stock has “looked after” them in the past or they are too proud to admit that they got it wrong I find people hold on for crazy reasons.

To ensure that you remove emotion from investing, you should implement a plan or set of rules. And it doesn’t have to be complicated. Having an exit plan is a good start.

Put in place a rule where you will sell off half your shares when you make a 10% profit. Or, if the stock decreases by 7%, you exit immediately.

 

Rule #7 Understand Debt

There’s an old school belief that debt is bad and you should steer clear of companies who carry it. The reason behind this is that debt will always be the first to get paid.

Companies will pay down their debt before the use the funds for growth and expansion. They will also pay down debt before the pay shareholders a dividend!

However, debt can be used as a tool for growing the business, providing they have the cash-flow to pay down the interest.

This works particularly well in an environment with low interest rates as it will have less of an impact on cash-flow.

If a company does have debt, be sure to look out for their debt to equity ratio (should be no higher than 2) from analysts and company reports.

 

Rule #8 Know How Interest Rates Impact Stocks

When the federal bank decides to increase interest rates, it has a flow on effect on the stock market.

When interest rates are increased, it’s an attempt to slow spending and decrease inflation.

The flow on effect relates to banks and interest rates. When the official cash rate is increased, bank will generally increase their interest rates on customers.

That means that people with a mortgage, personal loans or credit card debt will have to pay more interest, therefore having less discretionary income to spend.

Individuals will reduce spending on non-essentials like laptops and experiences so companies that offer these services will experience a decrease in sales.

When interest rates are decreased, the opposite is also true.

Whilst it will generally take 6-12 months for interest rates to have an impact on the economy, investor react immediately buying and selling stocks depending on the economy.

 

Rule #9 Yes, You Can Speculate On Stocks

This rule actually breaks a lot of other experts rules. They say to invest not to speculate. I say that you need to do both!

When Facebook listed on the stock market in 2012 at $38 a share, it was a speculative investment. In 1996, Apple stocks were trading for $0.78c.

Without speculative investors these prices would never have increased.

The truth is that all the professionals actually speculate. They don’t want to tell every day investors that because they don’t want to be responsible for any losses.

The secret here is that you must cap it. Cap your speculative investments to 10% of your portfolio to minimise the impact if they go wrong.

Note, it says that you CAN speculate not that you SHOULD. This is a risky type of investment that needs to fit your risk profile and investing goals.

 

Rule # 10 Stay in The Know

When it comes to being a successful investor, information is king! You want to be able to keep up to date with the latest news on your investments as well as an interviews and announcements made by management.

A simple way to keep on top of this information is to utilise Google Alerts. Set up alerts so that everyday you will get a notification email on the news related to that company.

After doing this for a while you will learn which sources to trust and separate the fake news from the real news.

 

Rule # 11 Investing is About the Future, Not The Past

Many investors get caught up in making investment decisions based on what  a company has done in the past.

This is a great way to ensure that you experience pain from investing.

Whilst the past provides important information, it need to be thought about when looking into the future.

Apple and iPhone sales are a great example. Apple users would upgrade their phone when the latest iPhone was released.

Often people would line up overnight to be one of the first to have the latest tech from their favourite company.

As an investor you need to be thinking ‘how long will this last?’ Will people still be able to upgrade every time when interest rates increase or unemployment rises?

Can Apple still continue to WOW their fans in the years to come. Both interest rates and consumer feedback has seen a 30% decrease in Apple stock value over recent times.

The smart investors will be researching and looking for information from management on what they are focusing on for the future.

 

 

 

Keen to learn more about investing? 

Follow my Youtube channel for up to date stock analysis and education

 

 

 

 

 

 

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