Let’s assume an investor is new(ish) to building an equity portfolio and that he has decided that he wants to invest $100,000 in Australian equities. In my last column, I showed that an investor can put $80,000 in an index exchange-traded fund (ETF) – say the SPDR S&P/ASX 200 Fund (STW) – and spread $20,000 equally across four stocks from the ASX 200, without facing too much volatility relative to the market.
Break the $80,000 up into four parcels of $20,000 for four separate entry points to average risk over time. Take care with placing a limit order. I once tried that with a sizeable order for STW and only one share (worth about $50) was bought at a brokerage of $19.95 – not a good deal. The market rose rapidly so I didn’t get set (except for my one stock) and my brokerage cost me about 40 per cent!
Unless you have access to market timing data that you trust, the first day of trading doesn’t really matter, unless the market is falling sharply – say, more than 1 per cent a day. It might be that the market flicks back up or goes further down. It is often better to wait for a quiet day. It really hurts the ego if the market keeps falling and falling. So, for me, it is better to lose a little and wait for at least some sign that the correction is over.
At intervals no closer than a week apart, place the other three parcels, noting the down-market syndrome. After about a month, our investor should have $80,000 set in the index. He will have learned a little about placing orders and the volatility of the market.
Next we need to choose the four stocks for him. I noted a few months ago in this column the stocks and sectors I avoid. That is step one. Choose your exclusion list, as it narrows down the research you must do to keep up-to-date.
The next step is to choose, say, three or four sectors, and a stock from each, from the ASX 100 (smaller cap stocks can be left for later in the strategy). The old standards like BHP, RIO, big banks, et cetera, come to mind – but they must fit with the investor’s philosophy and objectives.
Check their recommendations on the Reuters website (start with reuters.com/finance/stocks and drill down to the chosen stocks) and cull any stock that does not have a score of 2.5 or better (1 is the best). Buy each stock in parcels, at weekly intervals – as with the index. The next step is to start choosing a few more stocks for when new money comes into the investor’s fund – from concessional or non-concessional contributions. More care is now needed about which sectors/stocks to buy, as stock selection becomes increasingly more important with the value assigned to them.
Depending on risk tolerance, the universe of stocks can be extended to include the top 200. I am not sure anyone less than an expert should put self-managed super fund (SMSF) money outside the top 200.
The aim should be to get up to about 15 stocks over time. With no more contributions to the index after the initial four parcels, the dominance of the core will dissipate over the years. Indeed, if
a good “opportunity” comes along, the investor can think of selling the core and rebalancing into stocks – but only when he has the appropriate advice or training.
The aim of this simple strategy is to slow down the enthusiasm of buying 10 or 15 stocks in rapid succession. There is a learning process that is best learnt by “doing”. Also, if the market happens to move down quickly at the start of the process, the investor who is only in stocks might find the going tough and sell at a temporarily bad time. But no course of action is foolproof.
The vision of what the portfolio should look like after a couple of years requires lots of thought. Mine is very much that I keep the number of stocks at fewer than 20 so I can follow them all and read up on them and their recommendations. If I choose a smaller cap stock, then I like to split the work in that sector with one or two others of that ilk – to reduce the risk of single stock exposure. Having had a stock go to zero (MFS) during the GFC, I am not inclined to suffer that fate again.
The one pleasant problem I have not yet resolved in my own mind is how I should deal with a stock that rapidly climbs in value. To sell it off too quickly to keep balance in my portfolio will mean I never get a big return to offset my under-performing stocks. To hang on too long often ends in tears. I prefer a rule that states the maximum holding I might have in any stock of any market cap. Rapid growers tend to start as smaller in market cap and in my initial holding. So selling off when they look like growing towards my biggest holding is a halfway position that has so far worked for me.
But I do enjoy this problem the most.
Ron Bewley is an executive director of Woodhall Investment Research – www.woodhall.com.au
