Why you should build a well-diversified equity portfolio to grow wealth

Posted by: Uma Shashikant on Jul 10, 2017, 06.30 AM IST

A common accusation many readers make about this column is that while it encourages investing in equity, it does not carry specific recommendations about where to invest and how much. That kind of specific investment advice is quite dangerous, though it admittedly makes life easier for the investor.

Unless one is a financial adviser, and can take on the responsibility of monitoring how the recommended products are working, it is simply unethical to reel off names.

The question is not of expertise, but of the nature of the business of equity investing itself. Even the most intensive research can come up short when unexpected events impact businesses and markets.

There is no telling in advance. It is not as if I hold back something precious from the readers of this column; it is just that I cannot forecast the future.

A very comforting emotion is the sense of control. Investors want to believe that the equity investments they make will behave in a manner that they can predict, understand, control, and therefore not worry much about.

When they realise that things could go wrong; that their money could be at risk; or that their choices will perform poorly, not doing anything seems like a better place to be in. The comfort of a small fixed interest in the bank seems like a safer option. But that so harshly short changes your wealth.

Many investors know about the benefits of long-term investments in equity. What holds them back from acting, then? Two primary reasons I would think. First, the idea of a higher return must be associated with something concrete. The inability to associate a high return with a specific product makes them think that such examples are hypothetical.

Second, the lack of conviction in the process that can enable a higher return. When I point out that diversification is the only way to achieve better returns, I have lost my investor already. They want me to tell them whether they should buy stock A or stock B, and if I say that they should have both, and a dozen more, so they can manage risks better, investors fail to grasp the merit of this process. The adamant stance to know what can happen in the future clouds their decision-making process.

Let me offer a four-step process, which I hope will help many such investors who fail to make the decision to switch from low return fixed income products, to equity investing. Needless to add, equity is for the long run and for growth in the value of the investment. If you think you will need to draw the money in a short period of time, it is best left in the bank.

First, investing in equity is not about picking the right stocks. It is one thing to be amazed by the story of multi-baggers that made stupendous gains, but it is another to pick one before it becomes a winner. If you spend your time trying to pick stocks, you will have to allow for the many mistakes you will make in the process.

The learning curve is steep and the lessons harsh. If you are a first-time investor, choosing to let money idle in the bank rather than invest in equity, you could make expensive mistakes trying to dabble in stocks. Equity means the market as a whole or the asset class that invests in growing businesses. That is the orientation you must keep.

Second, a portfolio of stocks is better than individual bets. Since you cannot foresee the future, you have to begin with a bunch of stocks, and weed out whatever is going bad as you go along. If you are buying stocks, you should hold 20-25 equity stocks to be able to cushion yourself from the wrong decisions you could make.

Unless you run a company and are on its board as an inside investor, or have enough wealth to worry about risks, concentrated bets in a few stocks won’t take you too far. If you cannot construct and manage such a portfolio, buy an equity fund or an index fund. Define your search thus: You are looking for a portfolio of stocks, that will be actively managed to throw out what is not performing. You can buy and hold a portfolio passively, only if someone else is monitoring it for quality.

Third, equity investing involves both strategic and tactical choices. For example, if your intention is to be invested in large and well-known companies that are market leaders in their segment, an investment in a large-cap equity fund or a narrow index like the Nifty will serve your purpose. You will find that large-cap funds tactically modify their holdings in sectors and stocks to do better than the index.

The choices in equity funds and indices expands this choice of tactical holdings further, to midcap stocks, small-cap stocks, themes and sectors. Take a pyramid approach—more in strategic choices at the bottom and a tapered smaller holding in tactical portfolios.

Fourth, the process of selecting a specific fund can be simplified. Each fund house offers a lengthy list of products, but you are looking specifically for large-cap funds, mid- and small-cap funds, and themes and sectors if you are taking tactical calls. Discard all names that sound complex, and products that mix up too many things.

Look for a diversified portfolio and check if the fund has a 10-year track record. Compare its performance with the benchmark index year-on-year. If the fund has done better than the index in 7 out of 10 years, you should do fine.

I routinely receive queries that ask SIP or lump sum? How much should the SIP be? How many SIPs? In the larger scheme of things this will not matter; that you invested it in equity will. Once you begin investing, you will receive a folio number. You can add to it by buying at any time you wish, whenever you have surplus funds. Choose 4-5 funds or indices at the most. Begin investing and ensure that your money is not idle.

Over time, the benefits of having invested in equity, the merits of having your money in a portfolio, and the advantages of having someone to monitor the stocks in the portfolio, will all come into play to deliver wealth that you would be proud of accumulating. The bridge to cross is the conviction that a good process will deliver good returns, even if you cannot completely foresee or control it. That is the attitude to acquire.

(The author is Chairperson, Centre for Investment Education and Learning)

Disclaimer: The opinions expressed in this column are that of the writer. The facts and opinions expressed here do not reflect the views of www.economictimes.com. This article appeared in Economic Times dated Jul 10, 2017, 06.30 AM IST