A beginner's guide to constructing an Investment Portfolio
It goes without saying that everyone should endeavor to achieve financial independence. But in order to do so, you should first set up a comprehensive financial wellness plan.
Effective financial planning isn’t one built on a single stock idea or a single investment strategy. Instead, it is a process that helps you manage your resources properly to achieve both short- and long-term goals.
Short-term goals can include saving up for a holiday or refurnishing your living room. Meanwhile, your longer-term goals can include buying a home, funding your children’s education, building a sustainable retirement nest and leaving a legacy for your loved ones.
There are several components that make up a financial plan. Broadly speaking, having a holistic one should cover the areas of credit management, insurance, investment, home, retirement and estate planning.
Along with parking money in the bank, building up an investment portfolio is one common way to help you meet your financial goals. When executed well, it can go a long way to help you achieve overall financial wellness.
An investment portfolio can be defined as all the asset classes - stocks, bonds, unit trusts, property and gold - a person has invested in. Within a portfolio, the allocation of funds among assets can vary widely from one investor to another but can still meet each of his desired outcomes.
Since we know that there is a direct correlation between your financial goals and your investment portfolio, you will understand why adjusting your portfolio to build it up according to your life goals is essential.
So before you embark on building up an investment portfolio, here are some questions to ask yourself.
6 key points to consider when building an investment portfolio
1. How much should I start with?
There is no one-size-fits-all answer to how much you should invest. For example, as a young PMET or first jobber, you often do not have the means to make large, lumpsum investments.
In contrast, an individual nearing retirement is more likely to be armed with more cash on hand to make larger, one-time investment purchases as he/she has worked for many years and has built up wealth over that period. In addition, often, such an individual would have less liabilities (for example, the home loans are likely to be paid up).
Therefore, it is important for you to take note of your current circumstances before investing.
Given that you have a good gauge of your monthly salary, you should be able to set aside a fixed amount for investments every month.
In that vein, you will have an idea of how much is available for investment after accounting for your emergency savings (at least 3 to 6 months of your average monthly expenditure), household expenses, insurance premiums and loan repayments.
Do not to commit more than you can comfortably afford in the long term. This is important as you do not want to be caught in a situation where there are insufficient funds to cover unforeseen costs.
Yes, you can always turn to liquidating some of your investments prematurely. But this is not advisable as depending on prevailing market conditions, you might end up selling for less than what you had invested. Furthermore, this throws a spanner into the works for keeping to your investment plan too.
That said, if you are considerably young or have yet to invest due to not having the appropriate amount of cash on hand, there are several affordable ways to start investing.
a. Dollar-cost averaging
As the name suggests, dollar-cost averaging (DCA) allows the investor to split up the amount he/her wishes to invest across a time period. A fixed amount is set aside each month to buy investment products such as stocks, exchange-traded funds (ETFs) and/or unit trusts. Doing so allows the investor to reduce the impact of market volatility. It also avoids the pitfalls of timing the market wrongly, as seen below.
With DBS, you can invest in ETFs or unit trusts by DCA with a regular savings plan (RSP) like Invest-Saver. With Invest-Saver, you can invest for as low as S$100 a month and there is no need for a trading account or a CDP account (required for the purchase of individual Singapore-listed stocks).
If unforeseen circumstances result in you having to liquidate your investments, you do not have to worry about early withdrawal fees as there is no lock-in period.
DCA investing works best as a long-term investment tool for investors with a lower risk tolerance and do not have a large amount of cash to make lumpsum investments.
This makes it an attractive proposition for a first-time investor but above all, you should do your best to stick to your investment plan. That way, you are more likely to see it bear fruit.
b. Investing in ETFs
There are benefits to diversifying your investments such as minimizing the risk of loss if one investment performs badly over a period. Diversification also provides capital preservation as well as allow for the generation of returns from multiple sources.
If you are a first-time investor who has enough capital to do a lumpsum investment but not enough to build a wide-ranging stock portfolio, buying individual ETFs to build a portfolio may be the option for you.
This is because buying into one ETF gives investors access to the performance of a larger portfolio of stocks or bonds. For example, the SPDR Straits Times Index ETF holds 30 stocks to replicate the Singapore market index. There are even ETFs that allow you invest in themes like Technology or Medical plays.
Moreover, ETFs have lower costs compared to unit trusts. Management fees are lower because they are passively managed and do not employ fund managers for stock selection like for most unit trusts. These fund managers simply buy the stocks to replicate the underlying index.
ETFs suit investors who are not trying to get better returns than the underlying index – that is, people who are happy with matching the index in returns performance.
Choosing the appropriate mix of ETFs can create an optimal portfolio for your long-term goals.
Novice investors and even experienced heads have been turning more to Robo-advisors for investment and it’s easy to see why. Like ETFs, robo-advisors offer lower costs to entry and charge lower fees while providing investors with access to regional or global diversification.
Robo-advisors are digital investment platforms that provides investment management with moderate or no human intervention. A typical robo-advisor collects information from clients through an online survey, and then uses the data to offer advice and/or automatically invest client assets.
While usually automated and algorithm-driven, there are also hybrid robo-advisors in the market like DBS digiPortfolio, where professional fund managers work alongside automated processes like back-testing, rebalancing and monitoring.
This is one way of keeping costs low for investors while giving them the assurance that portfolio managers are keeping a keen eye on investment performance.
While not fully customizable to suit the needs of each individual investor, robo-advisors still provide a range of options for different investors.
Taking DBS digiPortfolio as an example, investors can invest in either an Asia-focused or global portfolio at varying risk tolerances.
There are conservative (Slow ‘n Steady), balanced (Comfy Crusin’) and aggressive (Fast n’ Furious) versions of the same portfolio. The higher up the risk spectrum, the more your portfolio is weighed to equities.
2. What is your personal investment philosophy?
Now that you know the different options for you to get started, we look at how an investment philosophy guides what you decide to invest and how much goes into each investment.
Before you embark on building one up from scratch, one of the key questions to ask yourself is what kind of investment strategy to adopt. This can be a lengthy process as there is a variety of approaches to choose from, each with its own pros and cons.
An investor usually builds a portfolio with a strategy in mind, which guides investment decisions based on goals, risk tolerance, and future needs for capital. In other words, it results in choosing the proportion of each financial instrument (e.g. stocks, bonds and alternatives) that make up your portfolio according to some key considerations for investing.
The three key considerations to start with when choosing an investment strategy include taking measures to understanding your:
- Investment goals/objectives
- Risk appetite
- Time horizon
Strategies include those that seek strong, rapid growth, where investors are more concerned with capital appreciation of stock prices. On the other hand, investors can choose to focus on generating dividend income and preserving wealth. This latter strategy is often considered lower risk than the former.
Investors can also look at adopting both styles. One such strategy that combines both these methodologies is the Barbell Strategy, one advocated by DBS Chief Investment Office (CIO) since August 2019.
Different investing styles will reap different results, but does it mean one style is better than the other? Probably not and with good reason as we all have different objectives for investing.
In all, it’s especially important that you understand your willingness to take risk in the markets.
For stocks, there are three common ways to classify them:
- Dividend stocks
- Growth stocks
- Value stocks
Also known as income stocks, these investments that are noted for paying relatively stable dividends often have stable share prices too. Dividend stocks may pay an increasing dividend over time as well.
Many dividend stocks are blue-chip companies that have a stable business and a strong track record of being responsible companies.
They might be less exciting than investing in companies heralded as the “next big thing” but they do give a sense of comfort to the conservative investor. Those looking at building an investment portfolio primarily for dividend income would usually invest more heavily in such companies.
While not a like-for-like substitute, Real Estate Investment Trusts (Reits) and business trusts also form part of the dividend-focused portfolio.
Overall, ideal dividend stocks to add to a portfolio are those that have a low price volatility, a dividend yield that is higher than government bond returns and a steady level of annual profit growth. Dividend growth for such stocks should also be at least level with inflation rates.
Although dividend stocks can be an attractive alternative for investors unwilling to risk their principal, their values may decline when interest rates rise.
These are companies that the market believes or expects to grow at above market average returns. Such companies are aggressively expanding and as a result, reinvest all earnings (if any) back into the business. As such, these stocks generally do not pay dividends.
While higher risk, growth companies have the potential to grow immensely in the future. Investors anticipate that they will earn money through capital gains when they eventually sell their shares in the future.
While every sector of the stock market has growth companies, those classified as one tend to have business operations reliant on emerging technologies that could be more entrenched in the future economy. This includes alternative energy, biomedical technologies and cloud computing among others.
Growth stocks can provide the investor with substantial returns, but they can carry a greater risk and may also experience greater price volatility.
Investing largely in growth companies is more suited to investors who can stomach more risk or those who are long-term investors. Such investors would have a higher tolerance for volatile share price swings.
Growth stocks are also more likely to be cyclical sensitive. This means they often perform during periods of strong of economic growth.
Value stocks are those that trade at a price below its intrinsic value, which is the value of a stock based on what a financial analyst estimates of a company’s fundamentals. As such, value stocks are undervalued in the current market environment but have the potential to grow and generate returns for investors in the future. Simply put, it is like buying a stock for less than it is worth.
Reasons for why such stocks are undervalued are varied. It could be due to public perception that has little to do with a company’s business operations or simply because the market has yet to discover value in a company.
Unlike growth stocks, value stocks are likely to have higher dividend payout ratios or low financial ratios such as price-to-book or price-earnings ratios.
While not considered low risk, value investing is often undertaken by moderately conservative investors who are looking for a lower risk option with a fair amount of upside potential.
There are crossovers between value investing and dividend investing. This is so as established companies with a stable business, income and cash flow are more likely to pay regular dividends to shareholders.
Value stocks also often tend to outperform in a volatile or deflating equity market environment.
3. Building up on your knowledge
For the regular Joe (or Jane), building up an investment portfolio can be an arduous task. There is much research to be done on individual companies and sectors. You should also match it up with your risk appetite, take note of the changing economic conditions and how they affect the stocks you have picked.
Yes, there is a good amount of reading required before you can feel confident about making your first stock or bond purchase, but you shouldn’t shy away from it. Do not forget that even successful investors and professional fund managers have to go through this learning journey.
Learning of the ins and outs of financial instruments and your personality as an investor takes time and patience.
Read books or take an investment course that deals with modern financial ideas. There are many texts that distill financial concepts into digestible and easy to read points.
Once you are more aware of how the market operates, you can then decide what works for you when it comes to investing.
Staying informed on current affairs and market trends can help you make timely decisions too.
Learning to be a successful investor does take time and your investment journey is likely to be a long one. That said, it will be worth your time and efforts.
Do remember that you are bound to make mistakes (even some experts get it wrong!), which is why it is important to acknowledge mistakes and learn from them.
You can understand your risk profile better with help from assessment tools like our risk tolerance questionnaire.
4. What is the appropriate asset allocation?
We have already covered the importance of understanding your financial situation and goals which is the first task in constructing a portfolio. Important factors to consider include your age and how much time you have to grow your investments, as well as the amount of capital to invest and your future income needs.
Secondly, you should take the time to arrive at your personal investing philosophy. This step is intrinsically linked to what the appropriate asset allocation for your portfolio would be.
As an individual investor, you need to know how to determine an asset allocation that best conforms to your personal investment goals and risk tolerance. In other words, your portfolio should meet your future capital requirements and give you peace of mind while doing so.
Generally, younger investors, who tend to have a longer time horizon, often take on higher amounts of risk while older investors steer toward lower risk investing.
Below is an example of an asset allocation for a balanced portfolio. This is a portfolio for investors that seek to capture modest capital growth through a balanced risk-and-return approach.
This is one example of how investors break down their portfolio. A more aggressive allocation tends to include more equities while a more conservative approach sees the investor holding more fixed income and less equities.
Once you've determined the right asset allocation, divide your capital between the appropriate asset classes. They can be further broken down into sub classes, with each having their own sector specific risks and returns.
For example, an investor might divide the portfolio's equity portion between different sectors and companies of different market capitalizations, and between domestic and foreign stocks. The bond portion might be allocated between those that are short-term and long-term, government debt versus corporate debt and so forth.
5. Putting your plan to action
Once you have determined your ideal asset allocation, you can start to build up your portfolio. How you set it up depends much on your current level of investment knowledge and experience.
If you are less experienced or have less time on your hands, you can consider using a combination of ETFs, robo-advisors and unit trusts. They allow you to build a diversified portfolio with relatively little cost.
As you gain experience, more investible funds can be allocated to individual stock picking. For the retail investor, individual bond picking might not be the best option, given the minimum investment sum for corporate bonds are usually very high. As such, investing in bond ETFs may be a better option.
Given you are building your investment portfolio from scratch, do not rush into it. Building one requires patience and can take a few months. One way to do so is to pick products that are trading at more attractive valuations. You can look at more richly priced sectors following a market correction.
As you progress, do not sleep at the wheel and assume your investment returns are a given. Review your portfolio regularly and re-balance it as and when needed.
By regularly reviewing the performance of your investments, you will be able to ensure that they are on track to achieving your goals. You should aim to do this even if you are a passive investor investing mainly in ETFs or unit trusts.
Do keep a look out for investment costs which are the fees associated with buying financial instruments. The higher they are, the more they will eat into your gains.
Disclaimers and Important Notice
This article is meant for information only and should not be relied upon as financial advice. Before making any decision to buy, sell or hold any investment or insurance product, you should seek advice from a financial adviser regarding its suitability.
All investments come with risks and you can lose money on your investment. Invest only if you understand and can monitor your investment. Diversify your investments and avoid investing a large portion of your money in a single product issuer.
Disclaimer for Investment and Life Insurance Products