How to Build A Long Term Portfolio?

Today’s financial marketplace is demanding and the key to building a healthy long term portfolio is to adapt according to its changing dynamics. But most of the time we overlook the constant need for speculation required to evaluate and assess the market and end up investing poorly.

It is extremely important to distribute your risk across stocks, bonds, mutual funds, and other instruments. Diversification of investment lowers portfolio volatility without reducing the expected returns.

The golden rule is to not invest more than 10% in a single stock or investment. Further, one should never put more than 15% of their money in any particular fund or ETF, or 25% in any particular industry. 

 

How do you keep track of all of this?

It is simple. 

As step 1, look into companies or stocks whose strategies and products attract you and then think of investing in them. It is crucial to remember that prior performance of any company/stock does not act as a guarantee for their performance in the future whereas, it is advisable to buy an investment stock which has had a good record over the last few years.

But that’s not enough. Various factors and diversification methods come into play when one thinks of building a long term portfolio. Most important of these factors include – client’s age, how much risk one can take, how much time will it take for the portfolio to recover in case of a loss. A  young investor in their 20s-30s, should allocate around 70% of their investable amount in equity, 20% in precious metals (including gold), and the remaining in fixed income. That being said, keeping in mind the constantly dynamic nature of the market, it is ideal for an investor to assess and adapt to market risks according to their age and follow something full proof.

Thumb Rule of 100

An investor should be able to hold a percentage of stocks equal to 100 minus their respective age. For example, a 60-year-old should have 40% of their holdings in equity, and remaining should be in fixed income. This arrangement helps in keeping returns balanced and minimizes the chances of heavy losses. 

We need to understand that our future needs are directly proportional to the amount of capital gain we desire. To achieve that, one needs to start building their portfolio at a very young age. Risk-taking behavior comparatively is much higher when a person is young as they can allocate more into equities in comparison to people of age whose prime focus is on moving towards fixed income. Therefore, one can start building up their portfolio in their 20’s itself. 

Despite all this, some people shy away from investing in the market even today. The main reason behind it is the lack of technical know-how. To overcome this problem, one should always seek help from someone who already has knowledge about it and is capable enough to advise about investing strategies. Not every individual is comfortable with taking higher risks that may or may not come with high returns. Therefore, one has to be aware of the appetite they have before taking any risk. The best way to go about it is to hire a Financial Advisor. After analyzing your risk appetency, the advisor will help you invest in the most efficient way possible.

I personally feel that to assure that your money is in the right hands, one should see which age bracket they are from and what investment bracket they seem to fit.

  • Aggressive Investor (20 – 30 years of age) –  Since they are highly risk-tolerant they can take aggresive positions. They can target 10% of their investment in debt and 90% of it in equity, which can be further broken down as 50% in mid-caps, 30% in small-caps, and 20% in large-caps. They can also invest the large cap portion in some tax-saving equity funds to get an aggressive yet balanced portfolio for better returns. 
  • Steady Investor (30 – 40 years of age) –  Target 20% of investment in debt and 80% in equity, which can be further broken down as 30% in large-caps, 40% in mid-caps, and 30% in small-caps. Tax-saving funds can also be included in this category. 
  • Balanced Investor (40 – 50 years of age) – The third category focuses more on a balanced approach while investing. These people should aim to have a balanced life and invest accordingly. Target 40% of investment in debt and 60% in equity, which can be further broken down as 50% in large-caps, 30% in mid-caps, and 20% in small-caps. Alternatively, one should allocate their equity in hybrid funds which are mostly debt-oriented for a lower risk profile portfolio. 
  • Risk-averse Investor (50 – 60 years of age) – The fourth category is for the people who do not want to take risks and want to feel secure while investing. Target 75% of their investment in debt and 25% in equity, which can be further broken down as 50% in large-caps, 45% in mid-caps, and 5% in small-caps. Hybrid funds can also save the day for this particular category. 
  • Risk-free Investor (more than 60 years of age) – The fifth and final category includes the people who want a fixed income and do not want to take risks of any sort. Target 95% of their investment in debt and 5% in equity, which can be further broken down as 70% in large-caps, 20% in mid-caps, and 10% in small-caps.

Keep in mind that the above is just a very generic break up of suggested investments.  if the target-investing period is over 7 years, then small and mid cap stocks are a better investment strategy, of course overall market and economic environment should be the most important criterion at all times.  If one is well versed in certain sectors of the market, it is advisable to allocate investment in those sectors. 

 

If your goal is to maximize returns by building a long term portfolio, start as an aggressive investor and then build upon it eventually. Develop a risk management policy and most importantly do whatever it takes to be patient. Being patient would lead to less poor decisions which means a potential investor would only invest when the odds are in their favor. It not only reduces the chances of making a mistake but also improves upon the investment returns. 

Another factor that comes into play when we talk about mutual funds in particular, is investing through the SIPs that is the Systematic Investment Plan. SIP is not a completely risk-free plan but will mitigate volatility and make you earn linear, market linked returns. One must always remember that they need to constantly keep an eye on their portfolio which means one needs to review and rebalance their portfolio according to their income and age, no more than once a year.

Following the above stated strategies, one can build family wealth by having everybody in the family invest in a part of their portfolio through Mutual Funds in SIP format. A mutual fund in SIP format is a game of balancing and reflecting through a bullish or bearish market. A mix of debt oriented mutual funds and equity will balance out and give positive returns eventually even if the market is bearish. It will also give exposure to a variety of shares and fixed income instruments at the same time, which will help in controlling the risk profile of the portfolio.

One must remember that their work does not stop just after investing, they need to constantly review and rebalance their portfolio every year taking the economy, the state of market and their risk tolerance into due consideration. This would help the individual to be calm instead of expecting sudden outcomes. One also needs to remember that they need to stay consistent and not pull out as soon as there is a sudden fall without consulting their respective financial advisor because even if SIP is the safest way to go it still does not mean it is completely risk- free.

Lastly, it is important to invest like an owner, because that’s when you will be much more careful and considerate about your investments. Do not panic because of market fluctuations; it only leads to being fearful and results in bad investment decisions. Relax and try to understand the consequences and parameters one can use to implement risk control strategies. Do not pull out when the market is bearish; instead, buy when you think others are fearful because intelligent minds always strike when the iron is hot.

By Shantanu Burman
Investment Banker & Entrepreneur