Follow a portfolio approach

Decisions! Decisions! Since you started investing in the stock markets, do you feel plagued by the number of decisions you have to make everyday? 'Should I sell that stock which has run up by 30 per cent, or should I wait? Now that real-estate stocks are running up, shouldn't I add a few to my portfolio? Do I buy large cap stocks or mid-cap ones now?'

Most of us make such decisions in an impulsive manner. But taking a 'portfolio approach' to such decisions can simplify them. This implies evaluating every decision for the impact it could have on your overall wealth. Here is how:

Diversify

You've read a positive article on software stocks and so want to go ahead and buy 10 'hot' IT stocks that you've spotted. Should you do that?

Well, that will depend on whether software stocks already take up a significant proportion of your overall portfolio. If they do, it may be best to refrain. If you don't own a single one, you can probably buy a few.

When too much of your savings is invested in one particular sector, swings in the fortunes of that sector (such as a sharp spike in the Rupee or a sub-prime crisis) will have a big impact on your overall returns. That can be a drag on your portfolio even when the broad market is zooming.

Making sure your portfolio is well-diversified across various businesses can reduce the blips in your overall returns. Typically, it may not be advisable to hold over 15-20 per cent of your portfolio in stocks from a single sector.

This advice also holds good for individual stocks. Your decision on how much to invest in a single stock should be determined not by the funds you can spare at the time but by the exposure the stock should have in your overall portfolio.

A friend has tipped you off that Great Riches Real Estate, now languishing at Rs 3, will zoom to Rs 10 in a month's time.

You are tempted to buy 20,000 shares, in the hope that you can pocket a profit of Rs 1.4 lakh. Now, assuming your overall portfolio is only Rs 5 lakh, stop and think! Would you really like to have one-fourth of your total wealth in a penny stock that may halve as quickly as it can double?

Even if the stocks you own are blue chips, it would still be advisable to stick to specific limits/weights for each stock in your portfolio.

Mutual funds are prohibited from holding more than 10 per cent of their assets in a single stock and that rule should be good enough for you as well.

Monitor

The sector- and stock-specific limits that you set for your portfolio apply not only when you make fresh purchases or sales but also on the stocks you already hold.

Remember, as stock prices run up swiftly, the value of the stocks you hold keeps rising/changing and so does the value of your investments in individual stocks and sectors.

Even if you are a long-term investor, it pays to review your portfolio, say, once a month (especially when markets are under fire), and check out the weights allocated to each stock and sector.

This way, you will be able to sell and lock into some profits in stocks that have seen a relentless rise, when they exceed your stock/sector limits. You don't have to agonise over whether the time is exactly ripe to sell a particular stock.

Financial Web sites offered by brokerages as well as media houses now allow you to store and monitor your portfolio on a real-time basis.

These make it easy for you to keep track of the weights occupied by different stocks and sectors in your portfolio.

Allocate

Should I buy momentum stocks for short-term gains and keep churning my portfolio? Or should I stick to blue chips and hope to make my money by holding them for several years?

Most investors are constantly torn between these two choices. The answer may, again, lie in adopting a portfolio approach. Buying momentum stocks for quick gains carries high risks.

Therefore, you should allocate only that portion of your portfolio to such stocks where you are prepared to handle significant capital losses.

If you have savings of Rs 5 lakh, but don't mind losing Rs 50,000 to capital losses in stock trading, then you can probably invest Rs 50,000-75,000 in low-value stocks.

Make sure your impulse purchases, made on tips or sheer 'intuition', never exceed these limits. One approach that may keep you from trading too much on your portfolio (and sacrificing a chunk of profits to brokerage and poor timing) is to divide your portfolio into a 'core' portion and a 'trading' portion. Make up the 'core' portfolio with stocks of good companies that you have thoroughly researched.

Hold these for the long term and resist temptation to exit and enter them on every small blip in prices. You could indulge in your whims in the stocks you pick for the 'trading' portion, but make sure that this portion remains within the limits of 'risk capital' that you have set aside.

Remember, setting stock and sector-specific limits may not be too difficult. But the challenge really lies in having the discipline to adhere to them, irrespective of which way the markets swing!