The Motley Fool

How To Build A Share Portfolio

It’s all very well finding individual companies to invest in, but how can you take this one step further and put them together into a share portfolio?

First off, let’s start by saying there is no definitively correct way to build a share portfolio. Like many things in investing, you often need to take the time to see what works for you and to find what you feel comfortable with.

But there are some guidelines we think you should follow if you want to invest Foolishly. With all of these, the overarching principle is that you want a mix of different types of businesses that will help smooth out and ups and downs that the stock market has on a regular basis. As the old saying goes, you don’t want to put all your eggs in one basket!

How many shares should you own?

Lot of studies have been to see how many shares you need to hold to have a well-diversified portfolio. Some say there is little benefit in holding more than 15 shares, as picking more than this often means your portfolio moves pretty much in lockstep with the overall market. Others believe the magic number is 30 shares, or even more.

What we can say is that the more shares you have, the harder it becomes to follow them closely. And once your individual position sizes fall below 1% or so, any one holding will have a limited impact on your overall portfolio if it does well. So it might make sense to concentrate on what you think are your best ideas.

How much money you have to invest is also an important consideration. Once you take into account the costs of buying and selling a share, having a position of less than £500 probably isn’t going to be cost effective. So if you have £5,000 to invest, this might suggest you aim for around 10 shares, and maybe you can add more money (and increase the number of positions you have) at a later date.

Another thing to bear in mind is that you don’t have to buy all the shares you want to own in a company in a single go. It might be a good idea to buy a smaller stake to begin with, and then to increase it over time if the company performs as you expect it to.

What sort of shares should you buy?

You’ll find that some companies are very sensitive to the economic cycle of boom and bust (often called cyclical stocks) while others tend to be much less volatile (called defensive stocks).

Cyclical stocks are companies like house builders and banks, who will often see their profits fall sharply or even make losses when the economy struggles, while defensive stocks include big consumer brand companies and utilities.

It makes sense to have a good mixture of the two types, otherwise many of your shares will lurch in the same direction at once. And while it might be tempting to think you can load up on cyclical stocks just before the economy turns up, and ditch them at the first sign of a recession, timing the market in this fashion is a lot more difficult than you might think!

It can also help to have a mixture of large companies (i.e. those in the FTSE 100 index), medium-sized (valued at, say, £500m to £2bn) and smaller ones (valued at £500m or less). You may well find that at certain times large companies are in favour some of the time, while at other times it’s smaller ones. So again, mixing things up can help smooth out your returns.

As a very general rule, smaller companies tend to be more volatile than larger ones, so you might want to bear than in mind when sizing your initial position, and the very smallest companies on the market (valued at less than £50m) are often consistently loss-making, highly speculative and, quite frankly, run for the benefit of their directors rather than their shareholders!

Another thing we suggest you avoid is picking a lot of shares from the same sector, like mining, oil or banks. Many investors fall into this trap, especially when a particular industry becomes the next “hot” thing. But individual sectors can fall in and out of fashion very quickly, and you can easily become unstuck if you have the majority of your cash in just one or two industries.

Should you buy non-UK shares?

A lot of companies these days, especially the largest ones on the UK market, sell their products and services all around the world these days. In fact, it’s reckoned about 70% of profits from FTSE 100 companies now come from outside the UK. So you could argue this means there is little need to invest in non-UK companies.

However, UK companies make up just 7% or so of the world’s listed companies by market value, so keeping your focus exclusively on domestically quoted shares rules out a lot of great stocks. There are also certain types of companies (big technology/Internet shares for examples) that aren’t well represented on the UK market. So we think it makes sense to look overseas for at least some of your holdings, although maybe only taking baby steps in this direction when you are in your first few years of investing.

Should you run your winners and cut your losers?

OK, so let’s assume you have already built up a share portfolio. How should you manage it going forward? Here at The Motley Fool we’re very much long-term holders of shares. We want to own businesses for years, if not decades, so we don’t like to chop and change all the time, second guessing what share prices will do next because of macro-economic factors. There’s good evidence to suggest that investors who trade more frequently perform worse, partly because they rack up more in charges.

However, very often you might find that after a little time has passed a few of your shares will do very well, most of them will be middling, and you’ll have a few big losers. So your portfolio could start to look a little unbalanced, and be overly concentrated in just a few shares.

Exactly what level “overly concentrated” is, though, is again a matter of personal preference. Some people will start to feel queasy with more than 5% in a single share, while others will be happy with 10%, or even 15%. It also depends on what sort of a company it is as well. If the company concerned is very speculative, then a little additional caution might be advisable!

In order to rebalance your portfolio a little, you could continue to add more cash over time, or you could sell some of your largest holdings and invest in other shares instead. At The Motley Fool, we generally believe that winning shares will tend to keep on winning. After all, their share prices have probably done well because their underlying business has performed well.  This means we might look to add to other positions where the business has done well, but the share price hasn’t grown quite as quickly.

What to do with losing positions is another difficult area for investors. Some people advocate getting rid of shares that fall in price, regardless of how the underlying business is performing. We tend to think differently, and generally we’re happy to keep hold of companies that continue to do the right things on an operational level and where the long-term story still looks intact.

One particular trap to avoid is thinking you need to get back to break even on every individual share that you hold. It can hurt to take a loss, but often it can be the right strategy to invest your money elsewhere, if the reasons you bought the share for in the first place no longer apply.

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