Thursday, April 21, 2011

Why building a stock portfolio is like buying a car

One of the requests I receive most often from blog readers and newsletter subscribers is to help them in building a ‘good’ stock portfolio. Many think that this is a trivial task. All they need is a list of ‘good’ stocks to buy. It is not that simple. A portfolio is not a ‘T’ shirt with a ‘L’ written on its label that will fit 90% of investors. It needs to be custom-tailored for a near perfect fit, to suit each individual investor’s background, experience, financial commitments, risk tolerance, and future plans.

But the real problem lies elsewhere. Most young investors can spare Rs 1 - 2 lakhs. Some have recently started earning and can only spare Rs 3000 – 5000 per month. These are insufficient amounts for building a ‘good’ stock portfolio. So, I use the analogy of buying a car.

One doesn’t go out and buy a car – specially if they have just started earning. Some prior planning is required. (Car loans are readily available nowadays, but the EMIs can burn a big hole in your pocket.) A better option may be to buy a scooter or motor cycle for immediate transportation needs. Even then, you need to learn the rules of the road, and get a driver’s licence before you buy anything.

Unfortunately, there is no licence required to invest in the stock market. Most small investors jump into the market without any knowledge of the basic rules of investing. No wonder their stocks crash and they suffer heavy injuries (to their savings). Grow your capital by regularly investing in fixed deposits, recurring deposits, PO MIS, ETFs, mutual fund units till you have sufficient capital to buy a ‘good’ car.

Can’t you buy Rs 3000 – 5000 worth of stocks every month? Yes, but which stocks? You can’t even buy 10 shares of Tata Steel. So you’ll probably buy 100 shares of Suzlon instead, or worse still, 800 shares of Cranes Software! Your risk of loss will increase proportionately. You are far better off investing that amount of money every month in a ‘good’ fund like DSPBR Top 100 or HDFC Prudence. After 5 or 6 years of regular savings, you may have sufficient capital for a ‘good’ portfolio.

How much is sufficient capital? I suggest Rs 5 lakhs as a bare minimum. Rs 10 lakhs is a more reasonable figure. Can’t cars be bought for Rs 1 - 2 lakhs? Yes, they can. But they won’t be ‘good’ cars. How about a used car? That may work, but is likely to require regular trips to the service centre for repairs. And you really can’t be sure if a used car is really a ‘good’ car. The previous owner may not have driven or maintained it properly.

Even with Rs 5 lakhs, you will only be able to buy a decent entry-level car. But if you are ready to spend Rs 10 lakhs, then your choice of ‘good’ cars increases significantly. And if you own a Rs 10 lakh car, chances are that you will take good care of it by following scheduled maintenance procedures, getting repairs done promptly, adding accessories that will enhance your driving comfort and experience.

A ‘good’ stock portfolio needs sufficient capital, and has to be nurtured and maintained as well – by keeping track of market happenings, individual stock results, using opportunities to book part profits or add more on dips. The emphasis should be on safety, and not about driving/investing recklessly.


Professional Advisors said...

Very practical approach for young earners. They come from college and have knowledge of their own subject. Some of them may belong to commerce subject, but they seldom have any experience of prevailing factors in Indian market. At the same time they don't have enough money to buy full piece of share of large-cap company. Diversification, hedging are also required from the beginning of investment as it is bloody battle-field not the play-ground. Till one feel self-confident about his own knowledge and experience, he should take the rout of mutual funds to get benefit of stock market and keep connection with market's movement to learn for future. Building stock portfolio require not only a handsome amount but also sufficient time to take care of it.

Manoj Tiwari

VJ said...

Great Post !! Thanks for your efforts

Jasi said...

Awesome post and super analogy. Right down to the details. It is something I have realized over the years with my personal experience. In stock market, you need quantity with quality. Lose one and you lose it all.

Thanks as always and please keep up the good work Sir!

Subhankar said...

@PA: Thanks for your appropriate comments, Manoj.

Youngster's love action and excitement - and many seek it in the stock market. But as I have taken pains to explain several times, money-making is boring and a game of patience.

@VJ: Appreciate the feedback.

@Jasi: Thanks - you are always generous with your comments.