Chapter: 11 Principles of Portfolio Management

Section: 4 How to Build a Successful Portfolio?

Building and managing a portfolio requires systematic approach and careful planning. Following general guidelines could be useful in creating and managing a portfolio:


1. Assess your fund availability: Take stock of your funds available for investment. They may be in the form of cash, in the bank account or loans with friends and relatives or any other form. 


2. Establish your investment objective: This is a very subjective aspect of the process. There are a number of factors that influence the objective, to name a few: age of the investor, other income sources, risk tolerance etc. Some investors may aim at capital preservation or some may expect monthly income.


3. Set aside a portion of your funds for emergency requirements: It is important to have a reserve for emergency requirements. Once the funds are invested, it may not be possible to withdraw in a short notice without incurring losses. It is advisable to keep these emergency funds in a bank account or money market mutual funds.


4. Based on your investment objectives and risk/return profile, develop an asset allocation strategy: That is, decide what percentage of your portfolio would be invested in stocks, bonds, mutual funds etc. Your asset allocation will be dynamic and would change with the market situation. For example, when the market seems to have reached its top, you would increase the fixed income allocation. Conversely, when it seems to have reached its bottom, you would increase your stock allocation.


5. After deciding on the asset allocation, decide upon the sector allocation within each asset class: For example, if you are investing 50% of your portfolio in stocks, you should determine how much of it would be invested in telecommunication sector, how much in tech stocks, how much in banking etc. The factors to consider are the growth prospects of the sector and the correlation between the sectors. The lower the correlation, the lower the portfolio risk would be.


6. Security selection: Within each sector, select the stocks that are undervalued according to your analysis and bonds that offer the best yield given their credit ratings.


7. Benchmark each asset allocation of your portfolio against some broad based index: For example, investments in US equities can be benchmarked against the S&P 500 Index while investments in Saudi market can be bench marked against the Tadawul All Share Index.


8. Rebalancing: Monitor and adjust your portfolio on regular basis.