The Art of Portfolio Building
What is an Ideal Portfolio?
In 2008-09, when I was starting with my investing journey, the word “portfolio” was completely alien to me.
I was taught by my parents to just save as much money as I could, and put it into a recurring deposit or take a loan to buy a residential property. Even my privileged boarding school education was not savvy enough to tell me that my hard-earned money should be going into multiple assets that would appreciate in value over the long term.
Forget having a portfolio, the true meaning of the word “asset” is not comprehended well by the majority of the population. An asset is something that not only appreciates in value, but also gives you a cash flow at some point. An asset is something that pays you, and a liability is something that you pay for. A stock is an asset; a car is a liability.
It was only after I started investing with intent in 2013 that I actually thought of reading up and acquiring financial literacy to better manage my personal finances. If you would like to read in detail about my investing journey and highlights of my portfolio, you may do so here.
From my studies, I learned that a portfolio is a collection of assets which can span various asset classes. However, everyone’s ideal portfolio would be different – a young adult in her 20s may have riskier assets, and an older person may have assets that focus on low-risk cash flows for retirement. It depends on the individual – and that is why it’s called Personal Finance.
So what would be the template of an ideal portfolio? According to me, a good portfolio would balance the following aspects:
- Return on investment
- Risk management
- Diversification of assets
- Allocation of Capital
Let us understand these in detail with examples.
The Art of Portfolio Building
Even though I put the return on investment as the first consideration above, I am more interested in how much risk I am exposed to. You can say I’m more of a risk-management guy than a returns guy. At the same time, returns are the reason we’re all in the market in the first place – so let us explore how we can maximise returns at a reasonable amount of risk while building a portfolio.
There is no doubt that equity instruments bring the highest annualized returns vis-à-vis other asset classes. There’s a reason I say “annualized” because new age asset classes like Crypto and NFTs do have an ability to spike returns in the short term by a bigger margin but not on a consistent basis.
My equity portfolio consists of:
- Equity mutual funds that target blue chips, small cap stocks and flexi cap schemes for the long term (CAGR of 17.7%)
- Index funds targeting S&P 500 and Nifty50 indices (CAGR of 14%)
- Personal stock portfolio with 17 high-quality, low-debt, profitable companies (CAGR of 21.3%)
- A small portion in Private Equity
As you can see, my returns from my equity portion of the portfolio have been realistic, consistent and market-beating. Again, keep in mind that as a retail investor you are not restricted by the rules that Mutual Funds and Portfolio Management Services (PMS) have to abide by. So you have a better chance at beating their returns if you do your due diligence, pick your stocks carefully and keep accumulating for the long term.
In my portfolio above, I have captured the growth of two major indices that I am bullish about – US S&P 500 and India’s Nifty50. At the same time, with the other mutual funds I am able to capture the growth of India’s blue chip and small cap companies – the returns on Small Cap Mutual Funds have been tremendous in the long term.
For example, SBI Small Cap Fund has given returns of 26.33% since inception (2013).
I shall be discussing my personal stock portfolio in another issue that will be dedicated to this particular topic. Check out my Spotify podcast where I discuss how I pick my stocks and educate others on the same, here: The Money Memo – A Podcast on Spotify
Risk Management
If you ask me whether I prefer superior returns at the cost of risk, my answer would be a resounding no. That is because I value my peace of mind over everything else. What’s the whole point of investing for a better and secure future if it keeps you up at night?
Hence, I personally put risk management above return on my investments. Some of the questions that I ask myself before I invest my hard-earned money on an asset are:
- Will my view on this asset remain the same after 5 years? If not, why am I investing in it?
- Is this asset fairly valued?
- What is my Risk-Reward Ratio (RRR) on this asset?
- If I go wrong, what’s the maximum loss I’m ready to take?
For the past 9-10 years, these questions have served me well. I still do the same if I find a new exciting pick or if I decide to take a considerable position on a stock. And I have to be honest, I have been wrong more than a few times. My first real estate investment was in 2014, when the real estate market was literally at its all-time high (ATH). As a young guy in his early 20s, I jumped the gun on a property to become a “home owner”. Back then, that was a “cool” epithet to have.
By the time I had possession and rented it out, Demonetization hit us and the real estate bubble burst – it has still not recovered. In some cities, residential real estate has given a CAGR return of 4.5% since then – paltry even compared to fixed deposits! But mistakes make you better at risk management, and this was my expensive lesson. Only respite for me in this case was that the rental income was almost 40% of my EMIs and the home loan was fully paid off within 6 years. I have stuck to buying land for the real estate part of my portfolio since then. Maybe you can learn from my dumb actions.
Diversification of Assets
This is my second favorite part of building a portfolio. In fact, diversifying your portfolio is what makes it a “portfolio” in the first place – just one asset would not necessarily be called so. It is almost like I derive a lot of joy in managing different assets and considering my portfolio like a legit business. I will write on how I developed that skill in another issue of The Money Memo.
So let’s see what are the assets a regular investor has access to:
- Equity instruments – Index Funds/ETFs, Mutual Funds, Stocks
- Gold – Sovereign Gold Bonds, Gold ETFs, Physical Gold
- Real Estate – Residential/Commercial Property, Land, REITs
- Debt – Debt Mutual Funds, G-Secs, Private Bonds
- Fixed and Recurring Deposits – Bank and NBFCs
- Govt Schemes – PPF, Sukanya Samriddhi etc.
- Pension Funds – National Pension Scheme
These are the asset classes that I have on my portfolio. Remember, it took me more than a decade to build it – but build I did. I cover how these assets work in detail in my Udemy course that can be accessed here:
Learn about Asset Classes in Detail
For someone starting from scratch, it would be beneficial to start with Index Funds and then graduate onto Equity Mutual Funds. Once you have an idea of how the market and the economy works, you may think of picking your own stocks. But remember, even the biggest funds fail to beat the indices in the long term.
I am invested in PPF and NPS for the tax exemptions and also because these are asset classes administered by the government which helps me in risk management. These assets are also easy to invest – a call to your bank’s relationship manager should do the trick. PPF can also be invested through Netbanking for most banks.
As far as Gold as an asset class is concerned, I invest regularly in Sovereign Gold Bonds (SGBs). I do this for two reasons – the first being that they’re issued by the RBI and poses no default risk, and secondly, they pay me a 2.5% annual interest on top of the appreciation in gold prices.
I’m also a big fan of sovereign debt – G-Secs and T-Bills for short term assets – which pay much more than an FD or Savings Bank account with zero risk (as you can see, risk is my main indicator in an asset). These are assets that new investors may look at when deciding between FDs and Debt instruments. If you think there are any more worthwhile assets that are easy to understand for an investor, please reach out to me on Twitter – @ajay_invests or on Instagram – @ajayinvests and let me know!
Allocation of Capital
While diversification is good, one must bear in mind that too much of anything can be a bad thing. And this applies to spreading yourself too thin, and not employing your capital in the right amounts in the right assets.
I personally like to allocate at least 70% of my capital to equity instruments – Index Funds, Equity Mutual Funds and my own personal stock portfolio. This is from the fact that I was in my early 20s when I started my investing journey, and at a younger age you can take a lot more short-term risk. This is because you have a longer runway when you’re younger and any losses can still be recouped if you indeed make a costly mistake.
Out of the rest 30%, I have allocated approximately 10% for real estate, 10% in Gold, 5% in debt instruments and the rest 5% in PPF and NPS. I have around 6-8 months of expenses in an FD which I keep as an emergency fund. I believe the emergency fund is an extremely important part of anyone’s life, and it should be one’s endeavor to get that in place as soon as possible.
As one grows older, or nears retirement, it would be wise to shift your capital allocation to safer assets like debt and gold because your runway is slowly getting shorter. In addition, one might want to move their capital to an asset that pays income during retirement – in such a scenario, your main concern is to beat inflation and maintain the value of your money, not to grow it. This is also a time when your NPS contributions will kick into action, and you start getting your annuities.
For those who have read The Intelligent Investor by Benjamin Graham, this strategy above would make sense. If you haven’t read this book, I strongly recommend you do so – Benjamin Graham was the original financial influencer, and his most devout student was Mr. Warren Buffett himself.
The intelligent investor is a realist who sells to optimists and buys from pessimists – Benjamin Graham
The Takeaway
Now that we have discussed what makes an ideal portfolio through my own portfolio-building journey, there is one question that only you can answer:
What should my portfolio look like?
You may use my portfolio as a template, because I’m a risk-averse investor and by God’s grace I have not lost money in the kind of assets that I have included above. It’s a conservative but forward-looking strategy to allocate my capital like I have done among the highest-quality assets that are available for me to invest today.
Like I mentioned in the start of this piece, peace of mind is the asset I value the most. Everything pales in comparison to that. So if you are one like me, maybe my lessons and strategy may help you design your own. And remember – there is no one-size-fits-all in personal finance. Every individual is different and this shows on their portfolio too.
So, go ahead and start your own journey in the art of building a well-rounded portfolio.
Happy investing and see you next week! Ajay