FORGET WARREN, AND BUILD YOUR OWN BUFFETT

Want to play the Street, but don’t know all the twists and turns? Chasing the Holy Grail of that “Perfect Portfolio”, but not sure where to begin? Don’t lose heart. It may not be as difficult as you imagine. ET Intelligence Group’s Ramkrishna Kashelkar suggests simple steps to help an average investor build a portfolio

An investor, who has never dreamt of becoming a Warren Buffet, may be impossible to find. After all, it is every investor's dream to possess a portfolio that beats the market year after year and is the talk of the town. What Mr Buffet has achieved in an investing career of over six decades may well be impossible for an average investor to replicate. But that is no reason to get disheartened. As they say “well begun is half done”. If the investor is able to create a robust equity portfolio, he would have already achieved half his goal. Just like sowing a seed, it will need minimal ongoing effort to maintain and grow the portfolio and patience to wait for the fruits to ripen. Building a perfect equity portfolio is not only a science, it is also an art. The aim should always be to maximise returns while reducing risks to a minimum.

PORTFOLIO RISK: The most general definition of investment risk is “volatility in returns over a period of time”. A stock's volatility is calculated with the help of a measure called 'beta', which represents the stock’s tendency to respond to swings in the market. It is crucial for an investor to manage the portfolio volatility in good as well as bad times. This can be achieved through proper asset allocation and diversification.

ASSET ALLOCATION: This is your most important decision when managing overall portfolio volatility. While in a broader sense this involves allocating resources to alternative investment avenues such as debt, gold, real estate and equity among others, we will mainly look at the equity angle.
Studies have shown that proper asset allocation is more important to long-term returns than specific investment choices. But since guessing which stocks or sectors will perform better at a given time is very difficult, diversification helps.

PORTFOLIO DIVERSIFICATION: Diversification means owning stocks as different from each other as possible. While individual stocks may tend to follow market movements closely, the total value of a well-diversified portfolio is not as responsive.
When it comes to how many stocks make up a really diversified portfolio, experts differ. For some around 15-16 is a good number while others say not less than 40. One thing is, however, certain — greater the diversification, lesser is the risk. However, this can not guarantee that the value of a portfolio won't fall in a market crash. But it certainly ensures that the long-term goals of the investors will be met. Mutual Funds are an easier option for investors without resources to achieve such diversification.

HOW TO DIVERSIFY

SECTORAL DIVERSIFICATION: The sectors that are out of fashion today may well catch the market's fancy a few months later. This market leadership by various sectors rotates unpredictably. A recent example would be the revival in valuation of paper companies after the AP Paper deal. Exposure to multiple sectors ensures that not only are such opportunities captured, but the impact of a negative surprise is also low.

DIVERSIFICATION BY SIZE: While small and mid-cap companies have the maximum potential for high-speed growth, large caps provide the necessary stability to a portfolio.

OWNERSHIP STRUCTURE: Apart from well-known business houses such as Tatas and Birlas, an investor should also have government-owned and multinational companies in her portfolio. Companies without a promoter group (L&T, ICICI Bank etc) and companies controlled by financial investors (Gokaldas Exports, etc) could be the other types.

GROWTH PHASE: The portfolio should also try to strike a balance in terms of the various growth phases that companies pass through. This could include companies expanding aggressively and those that are generating a substantial cash surplus.

GEOGRAPHY: One may also try to take exposure to overseas equity markets to truly diversify the portfolio. Even within the country, one should ensure that the companies are not concentrated in a single geographic region. Having looked at the basic principles of building a portfolio, it will be interesting to see how we can apply it to the current economic situation.

THE DON’TS
While it is necessary to know what to do, it is equally important to define what should be avoided when building a perfect portfolio. Here are some key points:
DON’T BUY ON TIPS
A retail investor is typically the last one to know of the tip. Hence he is most likely to invest when the stock has already run up and hence at a risk to lose money.

DON’T INVEST IN A COMPANY YOU DON’T UNDERSTAND
This is one of Warren Buffet’s well-known principles. Only a thorough study can give an investor enough confidence not to sell at the first sign of trouble

DON’T CONFUSE INVESTING AND TRADING
Trading is short-term and investing is long-term. Getting confused between the two can be a sure way to lose money.

DON’T PANIC AT SHORT-TERM TROUBLE WHEN YOUR GOALS ARE LONG-TERM
Volatility is the basic characteristic of a stock market. Capital erosion in short-term should be considered as normal.

IF YOU ARE GOING TO NEED CASH IN THE SHORT TERM, DON’T INVEST IN STOCKS
In stock markets one can benefit only if one can hold on for a reasonably long period.

DON’T HAVE EXCESSIVE EXPECTATIONS ABOUT RETURNS
If a fixed deposit gives you 10% per annum, equity investments should typically give a return of 18%-20% per annum. While you can occasionally find a multi-bagger, it is unreasonable to expect every scrip to turn into a multi-bagger.

DON’T TRY TO TIME THE MARKET
Timing the market, ie, buying at the exact bottom and selling at the exact top, is next to impossible. Take ‘Buy’ and ‘Sell’ calls based on your views on valuations

DON’T INVEST WITHOUT A PLAN
A well thought-out plan and discipline in implementing it can safeguard your portfolio from impulsive mistakes.