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How to Build a Profitable Investment Portfolio?

how to build an investment portfolio | marketfeed

In the world of investing, understanding how to build a profitable investment portfolio is key to achieving long-term financial success. Especially during market cycles like bull runs, investors often get caught up in a state of excitement, only to suffer losses when the market inevitably crashes. In this article, we’ll explore key strategies like diversification, risk management, and portfolio rebalancing to help you protect your investments, ensure steady growth, and reduce volatility.

The Bull Run Trap: How Investors Get Caught

During a bull run, two main things happen:

1. Existing investors pour more money into the market, pushing prices higher.
2. New investors jump into the market at high prices, hoping to ride the wave of profits.

    The result is widespread market euphoria. But this is also the point where market crashes often occur, leaving both seasoned and new investors trapped. Those who bought at higher prices or averaged up their investments during the bull run suffer the most when the market reverses/falls.

    This is why building a well-diversified and balanced portfolio is essential for safeguarding your investments during both bullish and bearish markets.

    Why Diversification Matters?

    Diversification is a term you’ve likely encountered in various financial discussions. But what does it truly mean? In essence, diversification involves spreading your investments across different asset classes to create a balanced portfolio. This strategy aims to shield your investments from the inevitable ups and downs of the market. Let’s break down the concept of diversification with an example:

    If you’re heavily invested in the Nifty50 index and also have investments in small-cap and mid-cap stocks, you may think your portfolio is diversified. However, when the Nifty50 falls, small-cap and mid-cap stocks tend to fall as well. In this case, you’re exposed to a similar risk across different segments of the market, which doesn’t truly represent a diversified portfolio.

    Non-Correlating Assets: The Key to True Diversification

    True diversification means investing in non-correlating assets—assets that don’t move in the same direction as the rest of your portfolio. For instance, pairing Nifty50 stocks with government securities like Gilt funds can create a balanced portfolio.

    When the stock market falls, government bonds, particularly top government security bonds (G-Secs), tend to rise. This inverse relationship between equities and bonds means that even if your equity investments take a hit during a market downturn, the bond portion of your portfolio may provide stability and potentially offset the losses.

    How Much Should You Diversify?

    When considering diversification, a common rule of thumb is to allocate your investments using the 100 minus your age formula. This means if you’re 30 years old, you should invest 70% in equities and the remaining 30% in bonds or other debt instruments.

    While this is a basic approach, there are additional factors to consider when building your portfolio. These include:

    • Your age and life stage
    • Investment goals and time horizon
    • Risk tolerance
    • Number of dependents and financial responsibilities

    The combination of these factors will help you assess how much to allocate to equities, bonds, and other asset classes. Your investment strategy should evolve based on where you are in life. For example, when you’re younger and earning less, you may be willing to take more risks and invest heavily in equities. As you grow older and your income and responsibilities increase, it might make sense to allocate more towards debt and gold to ensure stability in your portfolio.

    One key takeaway here is that investment strategies are not set in stone. They should evolve as your financial situation, goals, and risk tolerance change.

    The 80-20 Portfolio Rule

    An advanced version of the traditional “100 minus your age” formula is the 80-20 rule, which has gained popularity among investors looking for both growth and stability. This rule suggests that you allocate 80% of your investments to equities and 20% to safer assets like government securities and gold.

    This 80-20 allocation allows you to take advantage of the growth potential in equities while keeping a portion of your portfolio in safer assets. In times of market corrections, you can tap into your bond and gold investments and reallocate them into equities when prices are lower.

    Portfolio Rebalancing: Maintaining Stability Over Time

    Over time, your portfolio will shift due to market movements. For instance, during a stock market rally, the equity portion of your portfolio may grow from 80% to 90%, increasing the overall risk. In such cases, rebalancing your portfolio becomes necessary.

    Rebalancing involves selling a portion of your over-performing assets (maybe equities) and reinvesting the proceeds into underperforming assets (bonds or gold) to restore your original allocation. This process helps reduce risk and ensures that your portfolio remains aligned with your investment strategy.

    However, constantly buying and selling assets can trigger tax liabilities and transaction fees. To avoid this, consider increasing your allocation to safer assets (like bonds) during market rallies rather than selling your equities outright. This keeps your portfolio balanced without incurring unnecessary costs.

    The Role of Risk Management in Investing

    Risk management is an essential part of investing. Never invest 100% of your funds in equities, even if your goal is long-term growth. By having a diversified investment portfolio, you’re better prepared for any market condition.

    For example, if you’re saving for retirement and have invested everything in equities, a market crash just before retirement could severely impact your savings. A diversified approach ensures that you have a mix of assets that can withstand market volatility and provide liquidity when needed.

    Final Thoughts

    Building a profitable portfolio requires careful consideration of your investment strategy, risk tolerance, and market conditions. By diversifying across various asset classes and regularly rebalancing your portfolio, you can create a resilient investment strategy that withstands market fluctuations.

    As you embark on your investment journey, remember to adapt your strategy based on your evolving circumstances and financial goals. Whether you’re a seasoned investor or just starting, maintaining a balanced and diversified portfolio is key to long-term financial success.

    Happy investing! 🚀

    Watch the full video on this topic on marketfeed’s YouTube channel: Building a Profitable Portfolio: Tips and Tricks

    Categories
    Jargons

    Where Exactly to Invest For Financial Freedom?

    where to invest | marketfeed

    Suppose you have a current annual expense of ₹16 lakh. You would need approximately ₹1.43 crore every year to meet your expenses when you retire 32 years from now! You’d need a retirement corpus of ₹15 crores to be financially free. 

    We also saw investment portfolios that you can invest in to achieve this retirement corpus. But we didn’t discuss where exactly you need to invest to achieve those returns, or rather, where exactly to invest for financial freedom!

    Time Horizon-Based Portfolio Selection

    You can select portfolios with different returns based on the investment time horizon of your goal. Following are the different investment time horizons:

    where to invest - portfolio selection guide | marketfeed

    1. Short-term Goals

    • These are goals that are to be achieved in the next 1-3 years.
    • High exposure is to be given to safe asset classes as the goal is relatively closer.
    • A return of 8% CAGR can be targeted for these goals.

    2. Medium-term Goals

    • These are the goals that are to be achieved in the next 4-7 years.
    • More exposure is to be given to safe asset classes, while a small exposure can be given to the return-generating asset class, i.e., equity.
    • A return of 10% CAGR can be targeted for these goals.

    3. Long-term Goals

    • These are goals that are to be achieved in the next 8 years or later.
    • You should give high exposure to equity as the goal is relatively far away.
    • A reasonable exposure should also be given to safe asset classes to ensure the stability of the portfolio.
    • Returns of 16-20%+ CAGR can be targeted for these goals.
    • We have three different portfolios with conservative, moderately aggressive, and aggressive approaches giving 12%, 15%, and 18% CAGR, respectively.
    where to invest | marketfeed

    Asset Allocation

    We allocate our investments into different asset classes for returns and safety. We will be allocating our investments to three different assets:

    asset allocations | marketfeed

    1. Equity

    • Equity refers to the shares of companies.
    • Returns from equity investments are very high, and so is the risk.
    • You can expect returns of 12-20% CAGR depending on the stock.

      You can invest in equity in two ways:
    • Direct Stock Investments – buying stocks like Reliance and Tata Motors via a broker (like Zerodha, Groww, and Fyers).
    • Equity Mutual Funds. Learn about mutual funds here.

    2. Debt

    • Debt refers to the investment made in bonds.
    • When a company needs capital, it can borrow money from the public in consideration of an interest payment. These payments are fixed.
    • Returns in debt are moderate but the risk is low.
    • You can expect returns of approximately 6-8% CAGR from debt investments.
    • You can invest in debt via debt mutual funds.

    3. Gold

    • Gold has given a very good historical performance.
    • You can expect returns of 5-6% CAGR by investing in gold.
    • You can invest in gold via Gold BeES or Sovereign Gold Bonds (SGBs). To learn about Gold BeES and SGBs, click here.

    How Much to Invest in Each Asset:

    You can click here to access marketfeed’s calculator.

    It’s a READ-ONLY VERSION. You have to make a copy of the document to edit it.

    Instructions to Use the Calculator

    1. The link will take you to the read-only version of our “Where to Invest” Excel Calculator. Click on ‘Make a Copy’ under the File tab to create a copy of the calculator. You could also download the file as .xslx to use the calculator on Microsoft Excel.

    2. Edit or enter figures in the yellow cells only. Do not edit any cells other than those in yellow as it will interfere with the preset formulas.

    3. The calculator has 8 sheets:

    • 8% Short-Term Goal – To calculate asset allocation for short-term goals with a targeted return of 8% CAGR.
    • 10% Medium-Term Goal – To calculate asset allocation for medium-term goals with a targeted return of 10% CAGR.
    • 12% Conservative Long-Term Goal (No ELSS) – To calculate asset allocation for long-term goals through a conservative approach with a targeted return of 12% CAGR with no allocation to the ELSS category. To learn about Equity Linked Savings Scheme (ELSS), click here.
    • 12% Conservative Long-Term Goal (ELSS) – To calculate asset allocation for long-term goals through a conservative approach with a targeted return of 12% CAGR with allocations to the ELSS category.
    • 15% Moderately Aggressive Long-Term Goal – To calculate asset allocation for long-term goals through a moderately aggressive approach with a targeted return of 15% CAGR with allocations to the ELSS category.
    • 16-20% + Aggressive Long-Term Goal – To calculate asset allocation for long-term goals through an aggressive approach with a targeted return of 16-20%+ CAGR with allocations to the ELSS category.

    8% Short-Term Goal

    8% short-term goal | marketfeed

    Here are the steps to find your allocations:

    1. Enter the Goal Name.

    2. Input how far away your goal is (in years).

    3. Input the SIP amount.

    The SIP amount adjacent to the 8% portfolio presented by the goal planning calculator should be entered here.

    4. Start your SIP!

    The calculator will display to you the recommended fund to invest in, along with its respective category and asset class. Additionally, it will also show you the amount to be invested via SIP in different funds. It also shows the allocation-based return and a pie chart representing the allocation weightage.

    Also read: What is a Systematic Investment Plan (SIP)?

    10% Medium-Term Goal

    where to invest - 10% medium-term goal | marketfeed

    Here are the steps to find your allocations:

    1. Enter the Goal Name.

    2. Input how far away your goal is (in years).

    3. Input the SIP amount.

    The SIP amount adjacent to the 10% portfolio presented by the goal planning calculator should be typed here.

    4. Start your SIP!

    The calculator will show which fund to invest in, what category and asset class it belongs to, and the SIP amount to be invested in different funds. It also shows the allocation-based return and a pie chart representing the allocation weightage.

    12% Conservative Long-Term Goal (No ELSS)

    where to invest - 12% conservative long-term goal | marketfeed

    Here are the steps to find your allocations:

    1. Enter Goal Name

    2. Input how far away your goal is (in years).

    3. Input the SIP amount

    The SIP amount adjacent to the 12% portfolio presented by the goal planning calculator should be entered here.

    4. Start your SIP!

    The calculator will mention which fund to invest in, what category and asset class it belongs to, and the SIP amount to be invested in different funds. It also shows the allocation-based return and a pie chart representing the allocation weightage.

    12% Conservative Long-Term Goal (ELSS)

    ELSS | marketfeed

    Here are the steps to find your allocations:

    1. Enter Goal Name

    2. Input how far away your goal is (in years).

    3. Input the SIP amount

    The SIP amount adjacent to the 12% portfolio presented by the goal planning calculator should be entered here.

    4. Start your SIP!

    The calculator will display to you the recommended fund to invest in, along with its respective category and asset class. Additionally, it will also show you the amount to be invested via SIP in different funds. The investment strategy allocates the initial ₹1.5 lakhs of yearly investment to ELSS funds. It also shows the allocation-based return and a pie chart representing the allocation weightage.

    15% Moderately Aggressive Long-Term Goal (ELSS)

    15% ELSS goal | marketfeed

    Here are the steps to find your allocations;

    1. Enter Goal Name

    2. Input how far away your goal is (in years).

    3. Input the SIP amount

    The SIP amount adjacent to the 15% portfolio presented by the goal planning calculator should be typed in here.

    4. Start your SIP!

    The calculator will display to you the recommended fund to invest in, along with its respective category and asset class. Additionally, it will also show you the amount to be invested via SIP in different funds. The investment strategy allocates the initial ₹1.5 lakhs of yearly investment to ELSS funds. It also shows the allocation-based return and a pie chart representing the allocation weightage.

    16-20% + Aggressive Long-Term Goal

    where to invest - aggressive goal | marketfeed

    Here are the steps to find your allocations;

    1. Enter Goal Name

    2. Input how far away your goal is (in years).

    3. Input the SIP amount

    The SIP amount adjacent to the 16% portfolio presented by the goal planning calculator should be entered here.

    4. Start your SIP!

    The calculator will show which fund to invest in, what category and asset class it belongs to, and the SIP amount to be invested in different funds. The investment strategy allocates the initial ₹1.5 lakhs of yearly investment to ELSS funds and allocates a part of the investment to a direct stock portfolio, which will be learned to build in the coming modules. It also shows the allocation-based return and a pie chart representing the allocation weightage.

    In conclusion, there is no one-size-fits-all answer to the question of where and how much to invest to achieve financial freedom. The calculators in the previous and current chapters will help you find answers to these questions. In the next module, we will learn how to read and analyze the annual report and financial statements of a company, perform ratio analysis, and build a well-diversified stock portfolio on our own.