Building Your Own
Portfolio
When you buy any share of stocks, it becomes
part of your portfolio. Your portfolio includes
all your investments, whether it was cash, real
estate, stock, or stock mutual funds. Your objective is to build a portfolio that will help you
meet your current financial needs and achieve
your long-term financial goals.
Strategies
When you start building your portfolio, you
need a plan or a strategy to guide the decisions you make. Otherwise you could end up
buying and selling investments randomly and
falling short of your financial goals.
Buy and hold: If you are investing with longterm goals in mind, this needs you to build
a portfolio of a few solid stocks or mutual
funds and keep them through ups and downs
in the market. The expectation is that they
will gain value in the long run, despite some
short-term losses during downturns in the
stock market.
If you are constantly buying and selling, you
might miss out on this long-term growth and
pay a substantial amount in fees to authorized
persons. Of course this does not mean you
should hold onto a stock or mutual fund if
it consistently provides a smaller return than
comparable investments. You should not be
afraid to purchase new investments with your
earnings.
Asset allocation: Asset allocation means dividing your portfolio among different types of investments, called asset classes, such as stocks,
cash, and real estate. Some asset classes, such
as stock, have more potential for growth but
are also more volatile, while others, such as
cash, are more stable in price but often grow
more slowly. In addition, different classes perform best at different times, based on what is
happening in the overall economy.
By planning how much of your wealth you
are going to invest in each asset class you can
create the mix of growth and stability that is
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right for you. You can, also take advantages
of different market cycles. The allocation
you choose may be aggressive, moderate, or
conservative. An aggressive portfolio is more
heavy in stock, while a conservative portfolio
includes more cash and bonds.
Allocation Models
Allocation Stock Bonds Cash
Aggressive 80% 15% 5%
Moderate 60% 30% 10%
Conservative 40% 40% 20%
Diversification
Owning a variety of investments within each
asset class is also essential to achieving a
strong, balanced portfolio. For example, suppose you invest all your money in one or
two stocks, or stocks that are very similar to
each other because the companies that issue
the stock are all in the same business. In that
case, the growth and security of your entire
portfolio will depend on the performance of
a few companies or ones that are very similar.
If these investments suffer losses, you could
lose a substantial amount of money.
If you invest in several different types of stock,
on the other hand, you will be in a better position to protect your portfolio and benefit
from many different strong areas of the economy. For example, you may invest in large
and small companies, companies in different
sectors of the economy, some stocks with
growth potential and others that pay dividend
income.
Matching Investments to Goals and Risk
Tolerance
The investment distribution you choose for
your portfolio should be in line with your
financial goals and reflects your investment
style. If you have a high risk tolerance, you
may want to choose a more aggressive allocation. As you approach an important goal, like
retirement, it might be better to keep your
money in safer investments.
Measuring Portfolio Performance
Even after you have created a portfolio that
works for you, it is important to be careful
about your investments. You want to make
sure that they are performing as well as you
can reasonably expect them to, and that you
make changes to your portfolio to meet your
evolving goals. For example, you might decide
to sell a stock that has turned out to be much
riskier than what you have expected, especially if it means that your entire portfolio becomes more risky.
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It is a good idea to go through your portfolio
about once a year to evaluate each of your
investments and to make any necessary adjustments to your asset allocation.
Total Revenue
When you are trying to evaluate a stock or
a mutual fund’s performance, the first step is
to figure out its total revenue. This number
takes into account any gain or loss in value,
plus any dividends you received.
If you own a variety of investments, you may
find it difficult to evaluate their performance
in relation to each other. To compare return
across investments you can calculate the percentage revenue for each one of them.
You can calculate the percentage revenue by
dividing the total revenue by the initial cost of
the investment. For example, if you invested
3,700 Riyals in a stock with a total return of
750 Riyals, your percentage return would be
20%. And if you invested 70,000 Riyals in a
stock with a total return of 8,500 Riyals, your
percentage return would be only 12%. So in
this case, the smaller investment would have a
better percentage revenue.
Total revenue: 750 Riyals
= 20%
Purchase price: 3,700 Riyals
Using Benchmarks
In addition to calculating returns to evaluate
your investments, you can also look at your
investment’s performance in comparison to
the overall market by using a benchmark, or a
measuring criterion.
A benchmark is usually an index that tracks
the performance of a selection of stocks
within a market or a sector in order to measure the performance of the market or the
sector as a whole. Comparing your results to
an index can give you an idea of your portfolio’s performance.
For example, if stocks in your portfolio lost
5% last year while the stocks included in
the TASI index gained 15%, you might need
to reevaluate your individual investments to
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understand your disappointing results. But
make sure that the index you use tracks investments that are similar to the ones you
own, so you are comparing similar types of
investments. TADAWUL stock index or the
Saudi index or TASI is the index which tracks
the performance of the financial market plus
all the listed companies shares from all the
fifteen certified sectors in the Saudi financial
market.
When to Rebalance your Portfolio
As investments in your portfolio either gain
or lose value, your asset allocation might
change. That is because if one asset outgrows
the others, it will eventually take up more of
your portfolio than it did before. For example,
if your portfolio had 60% invested in stocks,
with 40% in other assets, and stocks performed very strongly over a period of time,
you might end up with 64% in stocks and only
36% in other assets. This could leave you exposed to more risk than what you intended.
One way to rebalance your portfolio, or restore the allocation you want, is to sell off
some of the assets that have grown the most,
and use the proceeds to purchase more of
the investments that have fallen behind. While
you may be hesitant to sell some of your most
valuable assets, you will be actually selling high
and buying low, which is a good strategy. You
can also use the money you set aside for investing each month to purchase more of the
lagging asset, until your allocation is back to
the balance you want it to have.
Some investors rebalance once a year, but you
may follow a different schedule depending on
your financial goals and changes in your life or
finances.
