Successful investing begins by conceding that - to a degree - uncertainty will always be your companion. Hence the first step in building a portfolio will be to determine your risk bearing capacity. On the basis of your risk taking ability you determine the extent of your portfolio you can allocate to equity, a process also called asset allocation. Asset allocation refers to spreading investments among different asset classes, not just different securities or market sectors.
As different asset classes are imperfectly correlated it allows you to boost returns while reducing your portfolio's volatility. Determining the quantum of assets to be invested in each asset class based on risk profile will help in protecting the portfolio in volatile times. Asset allocation has in the past allowed people to survive, prosper and build wealth during bear markets.
Focus on equity
But investing is not all about portfolio protection; it's about building wealth. It's about creating a retirement corpus or a substantial amount to bank upon. The idea is to leverage Indian macro economic situation to assist in wealth creation. This is possible by giving higher focus to equity portion of the portfolio. Equity investments do carry higher risk, but it's possible to minimize this risk with a judicious approach. Equity investment can be done in different approaches or styles. Investment style or an approach refers to a broad category that displays similar fundamental characteristics. Some of the well-known approaches to equity investing are income investing, growth investing and value investing.
This style of investing is best suited for investors with very low risk appetite and retirees who want regular income from their portfolio. The idea here is to invest in good quality dividend paying stocks. The price of these stocks generally does not fluctuate much. Most of the earnings of these companies are distributed as dividends. Companies generally pay dividends on a half yearly basis.
If you purchase several different stocks whose dividend payments are staggered you can structure a regular stream of income from your equity portfolio and additionally give you adequate protection to your portfolio on the downside. A dividend yield higher than the post-tax yields of fixed income securities is definitely a good option for investors who look for income investing. In general, companies with low growth prospects offer a high dividend yield, against those with high growth prospects.
This style of investing is more suitable for investors who can wait for a longer time for their returns and have a higher ability to bear risk. Growth investing is selecting and buying stock in companies that tend to grow substantially faster than others. The idea behind it is that a growth in earnings and/or revenues would directly correlate into an increase in the stock price. The other characteristics of growth stocks include higher than average P/E ratio and poor dividend payout because, fast-growing companies need their capital to finance their expansion. Most companies reinvest a high portion or all of their earnings in their own businesses.
Value like growth investing is for a patient investor as it will be a long time before the value of the company is recognized by the stock markets. This term describes the purchase of cheap, unpopular shares that is currently ignored by the markets. Suitable shares for value investing are those with high cash flow, dividends and earnings yields, and high ratios of sales and book value to share price. Over the very long run, value shares appear to outperform growth shares, possibly because of the greater volatility in these companies.
Whether you are income investor or value investor you need a good strategy to pick-up the stocks. You can judge a company by its numbers, management, brand value, competition in the industry and the growth of the future earnings. It's imperative that your equity portfolio should consist of 10-15 stocks spread across 2-5 sectors to diversify risk. There is no single approach to make you successful in equity investing but the combination of all the approaches in a balanced manner can give you the best returns at the current juncture.