10 Things to Keep in Mind while Building an Investment Portfolio

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Financial markets consist of a number of instruments that you can invest in. From a company listed on the exchanges, to agricultural products to oil or gold, an investor can put his money in a vast range of financial instruments. Among the most popular assets that are traded are equities. An equity portfolio is a collection of investments in the stock market. 

In today's booming stock markets, a well-constructed equity portfolio is vital to wealth creation. The equity markets in India are generating double-digit returns. Equity returns seem to dwarf the returns generated by all other asset classes. In this scenario, the big question that arises is, what are the things to keep in mind when making your equity portfolio?

1. Investment goals:

“Why are you investing?”, “What is the purpose of your investments?” Your goals could be marriage, education, planning a family, children’s education, buying a car, a house, to save taxes or simply to create a corpus. 

Before you make any investment decision, sit down and take an honest look at your entire financial situation -- especially if you’ve never made a financial plan before. The first step to successful investing is figuring out your goals and risk tolerance – either on your own or with the help of a financial professional. Once you have a clearer understanding of the whats and the whys, the next step is to set a time horizon to these goals. 

2. Basic understanding of the market

To be successful in the capital markets, you must have a little understanding of the basics. A little knowledge about the market would go a long way in having a positive effect on your portfolio's performance.

3. Risk taking ability:

All equity investments involve some degree of risk. The reward for taking on risk is the potential for a greater investment return. If you have a financial goal with a long time horizon, you are likely to make more money by carefully investing in asset categories with greater risk, like stocks or bonds, rather than restricting your investments to assets with less risk, like cash equivalents. 

Let’s understand this through an example of Mr. Ajay with low income and low risk appetite. 

Salary of the person: Rs 60,000

Investable corpus: Rs 10,000

Balance: Rs 50,000

Risk taking ability: Low

Assuming Mr. Ajay invested his money in an equity index fund benchmarked to Sensex. Sensex is down at least 25% as on April 16 on a year to date basis. This would mean that He would lose at least Rs 2,500 of his money, in case he chooses to redeem his investment today. 

In this situation, how has investing just in equities with a low risk appetite harmed Mr. Ajay?

He is left with only Rs 7,500 from his invested sum. Say he had an emergency situation and required at least Rs 11,000 at the end of six months from his investment. 

Let’s highlight at least two problems with his investment.

No Diversification: Here, he invested all your money in Sensex and the index has fallen during his required tenure. He could not take the benefit of any other investment that may have taken off well during the same period. 

Low Risk: He has incurred a loss on his investment and he will have to curb his other expenses and use some money from his balance amount, which is Rs 50,000 to fund his emergency.

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4. Manage balance of Your Risks and Goals

With Inclusion of asset categories with investment returns that move up and down under different market conditions within a portfolio, an investor can help protect against significant losses. 

For Instance, suppose you want to achieve a set corpus for your daughter’s marriage in say 20 years. If you invest in high risk-high reward equities, you may be able to accumulate the required corpus by investing a lesser monthly amount as high returns are expected.

5. Maintain emergency fund:

It is vital to enough money in a savings product to cover an emergency, like sudden unemployment. Some make sure they have up to six months of their income in savings so that they know it will absolutely be there for them when they need it. 

6. Diversify

One of the safest ways to avoid losses and to keep your portfolio healthy is to invest in a variety of securities rather than investing all of your money in a single place. Diversification spreads the risk over different securities, and your portfolio is not affected negatively if one of your investments turns bad.

7. Disciplined investing

A healthy portfolio requires you to invest in it regularly and in a disciplined way. If you have a constant income, you should try to invest in your portfolio as frequently as possible. If you lose your job or you retire, these investments will help you achieve financial freedom even when you don't have a regular source of income.

8. Monitoring investments

The best way to manage your portfolio is to continually track your investments' position in the market. Bad investments equal weak portfolio performance, which further results in massive losses. By monitoring investments, you can cut your losses by knowing which investments have the potential to grow and which should be sold immediately to protect your portfolio's performance.

9. Financial advisors

Portfolio management has become a necessity if you have more than one investment. A good equity portfolio requires a basic understanding of market trends and contributing factors, it is never too late to consult a financial advisor if you think your equity portfolio is in a bad shape.

10. Tax liability

Good portfolio management includes considering tax liabilities. A portfolio of investments in a tax-deferred account will grow your wealth faster than investments in a tax-liable account. Since you will have to pay taxes on the amount withdrawn from your retirement fund account and other earnings, you should consider investing in places where you can save taxes and thus, decrease your taxable income.

Wrapping up

These are some very practical pointers about 10 things to keep in mind when making your equity portfolio. Following close on the heels of this module on the From spectator to shareholder is our next module, which gets into the details of Tax Saving. Keep reading to know all about how investors and traders can save taxes.

A Quick Recap:

  • Before you make any investment decision, sit down and take an honest look at your entire financial situation -- especially if you’ve never made a financial plan before.
  • All equity investments involve some degree of risk. The reward for taking on risk is the potential for a greater investment return.
  • The best way to manage your portfolio is to continually track your investments' position in the market.
  • Bad investments equal weak portfolio performance, which further results in massive losses.
  • Good portfolio management includes considering tax liabilities.
  • It is never too late to consult a financial advisor if you think your equity portfolio is in a bad shape.
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