Q: "What is the key to a successful portfolio?" A Seeking Alpha user asked me.
A: There are many different ways to create a successful portfolio, but the first thing you need is a plan. Now you need to make a plan that you stick to and from which you make no exceptions. Now, the first thing you need to come up with when making a plan is your investing strategy. Now there are many different market strategies: Value investing, Growth investing, ex-dividend date investing, fundamental investing, technical investing, Buy and Hold and more.
I am first going to tell you a little about each type of investing and then continue with how to make a successful portfolio.
- Value Investing: Value investing is when you invest in 'value stocks'. Value stocks are stocks that have lower amount of volatility and have high amounts of 'value'. Value can be rated on how well the company can perform in a bull market or having higher earnings (but not a high growth annually). Value investing tends to be more conservative has when you value invest you aren't planning to try and get the big bucks but keep your portfolio at a low volatility rating. An example of a value stock is McDonald's (NYSE:MCD).
- Growth Investing: Growth investing is like value investing only you invest in 'growth stocks'. Growth stocks don't have an average amount of volatility and it can range from many different levels. But what makes a growth stock a growth stock is its past history of growth in revenue and market capitalization and forecasts of that continued growth. Growth stocks tend to be more risky as growing stocks always tend to be. It is for younger investors (as the younger you are the more risk you are suppose to put in your portfolio).
- Ex-Dividend Date Investing: Ex-dividend date investing is not my favorite choice of investing but that's only my opinion. This investing strategy is when you buy high dividend yield stocks the day before its ex-dividend date, even though you might have to wait a whole month till you get the dividend. It is quick buying and selling and guarantees revenue from the dividends but what is the use of a 1.5% dividend if the stock falls 2.1%. That's my point.
- Fundamental Investing: Fundamental investing is a strategy that doesn't have to do with picking a certain group of stocks like 'growth stocks' or 'value stocks'. It is picking a stock based on its fundamental strength. Now fundamental strength of a company can be based on your opinions but is the overall strength determined by annual reports, news, and the stocks standard ratios.
- Technical Investing: Technical investing is like fundamental investing at the part that you don't invest in a certain group of stocks. You pick your investments based on trends in the stock price and if a stock is at a steady rise and has a dip then you need to look at the historical trends to decide if either: due to the historical reappearance of the dip and continually goes back up, then you invest in it; but if it has a history of continually falling far and not rising to the peak before the fall then don't invest or sell. All it takes to invest technically is by having a site that has advanced charting of a stock like Finviz.com.
- Buy and Hold: Buy and Hold is the most commonly used market strategies and is one of the most effective. It is just what the name says, you buy the stock, then hold it for a long period of time. I find it very effective and is the strategy I recommend the most.
Now, these are the most common market strategies used but there are plenty more, like DCA. But now back to the creating a plan. The next thing you need to create is different requirements for the stock to have to pass to invest in it.
Now I will list some of the ideas of what you should put on the requirements to help you pick your investment, and remember what you make as your requirements might effect your investing strategy.
- Standard Ratios: The main thing you need to make as a requirement is the standard ratios. These would include, P/E ratio (Price Earnings), P/S ratio (Price Sales), and EPS (Earnings Per Share). You need to set guidelines to how high it can be at most or how low it can be at least. And for the EPS you need to set guidelines for the least amount of growth (for EPS) you will tolerate. These are very important as they resemble the overall growth and strength of a company financially.
- Next you need to use analyst recommendations and forecasts to determine if the stock is forecasted to go in a bull or bear and only allow bull. For the forecasts you don't use the top and least for the forecast but you should take the median of the middle and top; and the median of the middle and lower. And you should only take a stock that's lower median is in a bull state. Then for analyst recommendations you need to set a level that the stock must be lower than to buy and higher than to buy (1=buy;5=sell: Lower than 2.5 is a buy for me and higher than 3.5 is a sell for me). These analyst guidelines are important to set and could be very hurtful to your portfolio if you don't follow them.
- You need to fix the amount of tolerated growth: revenue, gross margin, cash, and sales. These having growth show for more growth in the future of the company. And the bigger a company is financially the higher the stock price will go up. That is the reason these data points are so important. But when you are making guidelines for the growth, you have it as percentage (%) growth.
Now after you have set your guidelines on its data, you must figure out how you plan to invest in the stock. You need different market ideas to keep you portfolio. And one of the things that you need for that to happen is diversification of your portfolio.
- You need a diversification of market capitalization. You need diversification of different market caps because different cap levels hold different risks and another thing you need for your portfolio diversification is risk.
- The next thing you need to diversify is the sectors. The reason you need to diversify the sectors you invest in is that if you have lots of..Lets say the technology sector, and that sector has a decrease over the next three months then you don't have the other sector results to balance out the loses.
- Next you need to find how much you need to invest in bonds, stocks, and cash (stocks include ETF's and Mutual Funds). Now there is a simple formula that you can use that is determined by your age. S = 100 - A (stock percentage = 100 - your age). The reason you do this is because your age determines how much risk you should take. Now if you are 35, you have 65% of your portfolio in stocks, then you should have 5% of your portfolio in cash, and the rest in bonds.
Now these are the key components to having a successful portfolio. You should also add certain components for the requirements of a stock and find more ways to diversify. But there is a problem with over diversification, which pretty much means you over diversify your portfolio. But the main part that you need to learn is your strategy for your portfolio (that includes market strategy, stock requirements, and diversification). But the one rule that you must remember for the rest of your investing life is to never make exceptions to the rules that you set up.