A safe strategy for building a stock portfolio – Part 2

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In the first part of this two-part series, I explained the strategy behind gradually building a portfolio by starting with a core satellite approach. I also looked at when to buy your stocks and how to choose them.

This week, let’s start to build the portfolio further by choosing a few more stocks for when new money comes into the fund – from concessional or non-concessional contributions.

Tread carefully

More care is now needed about which sectors and stocks to buy as stock selection becomes increasingly more important with the value assigned to them. Depending on risk tolerance, the universe of stocks can be extended to include the top 200.

I am not sure that anyone less than an expert should put DIY super funds outside the 200. I hardly ever have more than one such stock (usually none) and any such stocks would have the lowest weights in my portfolio.

How many stocks?

The aim should roughly be to get up to about 15 stocks over time. With no more contributions to the index exchange-traded fund (ETF) after the initial four parcels (totalling $80,000), the dominance of the core will dissipate over the years as new money is invested.

Indeed, if a good ‘opportunity’ comes along, the investor can think of selling the core and rebalancing into stocks – but only with the appropriate advice or training. Recall how I dodged a few bullets in August last year by selling SPDR’s index ETF STW (read, Special Feature: How I handled the market dive).

The aim of this simple strategy is to slow down the enthusiasm of buying 10 or 15 stocks in rapid succession. There is a learning process that is best learnt by ‘doing’. Also, if the market happens to move down quickly at the start of the process, the investor who is only in stocks (and not the index) might find the going tough and sell at a temporary bad time. But no course of action is foolproof.

Have a vision

The vision of what the portfolio should look like after a couple of years requires lots of thought. Mine is very much that I keep the number of stocks at less than 20 so that I can follow them all and read up on them and their recommendations – every day!

If I choose a smaller cap stock, then I like to split the work in that sector with one or two others of that ilk to reduce the risk of single stock exposure. Having had a stock go to zero (MFS) during the GFC, I am not inclined to suffer that fate again. Being a so-called ‘expert’ does not dull the pain.

Dealing with price gains

The one pleasant problem I have not yet resolved properly in my own mind is how I should deal with a stock that I own (such as Lynas, LYC) that rapidly climbs in value.

To sell it off too quickly to keep balance in my portfolio will mean I never get a big return to offset my under-performing stocks. To hang on too long often ends in tears. I prefer a rule that states the maximum holding I might have in any stock of any market cap.

Rapid growers in price tend to start as smaller cap stocks and of smaller weight in my initial holding. So selling off when they look like growing towards my biggest holding is a halfway position that has so far worked for me. But I do enjoy this problem the most. I previously wrote about how I handled the situation for Lynas. If I get a general rule, I am happy to share it with you and revisit the issue in a future contribution!

Ron Bewley, Executive Director, Woodhall Investment Research.

Important information: This content has been prepared without taking account of the objectives, financial situation or needs of any particular individual. It does not constitute formal advice. For this reason, any individual should, before acting, consider the appropriateness of the information, having regard to the individual’s objectives, financial situation and needs and, if necessary, seek appropriate professional advice.

Also in the Switzer Super Report

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