Rules To Build A Basic Stock Portfolio

by Tim P. on 2009-12-037

Our contributing writer, Tim Parker, is a part time stock picker who’s put together his own stock portfolio. Here, he explains his stock investing strategy.

Have you noticed what I have noticed? Maybe I’m in the minority but it seems that all the websites, financial news networks, and other financial media are quick to say that they cater to the part time or “retail” investor. In my experience they don’t.

I don’t know about you but I have a full time job outside of the investing world and if I were to sit at my desk and watch the stock tickers all day, I would quickly be unemployed. If I were to spend hours each day researching stock picks and P/E ratios rather than finding ways to increase my value as an employee, I would, again, be quickly unemployed.

While it is true that a good investor is always working hard to learn something new, I’m a teacher and in the world of education, if you aren’t improving your skills, you’re losing relevance in your field. If you have a full time job, you’re probably thinking the same thing.

Turn on the news and what do you see? People talking about Libor, futures markets, commodities, and day trading. How many “retail” investors have time to keep up with that? First, it’s important to remember that us “retail” folks can’t realistically expect to make thousands of dollars per week like the pros can. We don’t have the time nor the money.

basic stock portfolio
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So can a part time investor actually do well? But of course. Like many who are interested in doing more with their savings, I’ve learned a few investment lessons through experience. Since I enjoy doing my own stock picking, I’ll discuss some of my own tips here for setting up a portfolio of independent stocks (as opposed to fund investing, which is what most part time investors prefer to do).

7 Rules For Building A Basic Stock Portfolio

With the right expectations, we can still make money in the stock market but often, our expectations need to change. Following are my basic tips on how to develop a successful stock portfolio and the rules I follow to select the right stocks to own.

  1. Listen to those who are making money. Of course, the hardest part about building a stock portfolio is picking the right stocks. This is the subject of many books and articles, and everybody has their own way of figuring this out. You can learn by listening to those who are making money. I’ve admitted before that I follow and study Jim Cramer’s stock ideas (your mileage may vary on this one).
  2. Understand the difference between a stock’s price and its value. My second word of advice for stock pickers is that they should use common sense. Think about it: you would never go to a store and buy something on the clearance rack hoping that down the road it will be just as valuable as the more expensive, popular items that are available. Yet amateurs and novices do this with stocks every day. Of course there’s a chance for stocks to appreciate, but you’ll need to make sure that you buy stocks that have value. Just don’t forget that price does not necessarily equate to value.
  3. We need to take at least a medium term approach. Hold stocks for a minimum of a year if possible.
  4. Go for quality stocks that pay a good dividend, so you’re sure to make money simply by holding a stock. For a relatively conservative portfolio, look at the stock of strong companies that pay a dividend. Earning dividends is like earning a yield on a high interest savings account. Regardless of how the stock does, you’re still getting paid to hold it. Now if you decide to hold a stock that doesn’t pay a dividend, then you should have a lot of confidence in its potential to grow.
  5. Buy stock in large, solid companies or blue chip companies, so that if you don’t have to time to watch your investment during a given week, you won’t have to worry about these companies going out of business.
  6. Mutual funds and index funds may be the much better approach for those who want to get immediate diversification.
  7. Avoid day trading or timing the market in the short term. Finally, the retail or part time investor should avoid timing the market on a short term basis. If you don’t have much time to spend assessing stocks and the markets, then you should instead think of a less active investing approach; in this case, it helps to think long term.

My Stock Portfolio and Latest Investment Returns

While average investors should make sure their money is diversified adequately into various asset classes, there may be room in their investment arsenal for an individual stock portfolio (which should be a small part of a larger, diversified core portfolio). For those who subscribe to this philosophy, I’d like to introduce you to something that I put together using my aforementioned rules. My “No Hassle Stock Portfolio” is a small collection of stocks that uses these rules. Currently, there are only 5 stocks in this particular portfolio. They were all picked when they were undervalued. Some have made a lot of money and some remain undervalued. I did my research on these stocks and thus far, they’ve performed reasonably well (yes, and so has the DJIA 🙂 ). Here are the particulars:

  • GE (General Electric Company) – 200 Shares @ $11.75
  • HD (The Home Depot, Inc.) – 100 Shares @ $22.81
  • BAC (Bank of America Corporation) – 200 Shares @12.89
  • WEN (Wendy’s Arby’s Group Inc.) – 400 Shares @$5.38
  • MRO (Marathon Oil Corporation) – 100 Shares @$33.48

The No Hassle Portfolio is something I’ve developed for myself, a retail investor. You don’t have to log onto your brokerage to watch your stocks every day. You don’t have to try to make the impossible predictions of day to day market moves, and with dividends being paid on each stock, you are getting paid to hold the stocks. I expect to hold these stocks for 1 to 5 years.

It’s very important to note, however, that this sample portfolio is something I present here for informational purposes only and is by no means something I would recommend for you to follow blindly. I would suggest that you study these (or other stocks) on your own and make your own decision about your personal investments.

While I recommend a 1 to 5 year holding period (at least), I also personally advocate taking some of the money out of a stock when it runs up in value, then buying it back when it dips. This will be noted as stock market timing — which has its critics — but it’s certainly one approach an experienced investor can take. I don’t sell the whole investment. As an example, if I own 500 shares that have gone up 25%, I would typically sell 200 shares and buy those 200 back when it goes down in value. This is as fancy as I’d get. Other than that, I hold on to the stocks.

The good news is that this portfolio has gained more than 20% in less than two months! Now there’s one other thing I try to do — and that’s to give back. I donate a portion of my profits to charity and I’ve encouraged anyone who develops their own portfolio to think about doing the same — perhaps to give at least 10% of their returns to a charity or worthy cause of their choice.

If you’re interested in The Digerati Life’s take on stock market investing, you can review this post on how to beat the average investor’s returns.

Copyright © 2009 The Digerati Life. All Rights Reserved.

{ 7 comments… read them below or add one }

Michael Harr @ TodayForward December 4, 2009 at 8:04 am

@Tim – Is this the entire portfolio? Owning a portfolio with only five issues means you are taking on a scary level of risk. Also, have you considered tracking this portfolio using Mint or an equivalent service that will measure performance relative to a benchmark index? I’d be interested to see how you fare over the course of the next business cycle.

By the way, I have seen a large cap portfolio (one) built in a similar fashion that had delivered solid returns at significantly less risk than the S&P 500. It had about 30 issues and was well diversified among blue chips with some of the standouts being in the ‘sin’ industries – alcohol, tobacco, and energy. Of course, this was just the large cap stock portion of the portfolio, but its risk/return characteristics were solid.

I get that this is a kind of no-frills approach, but it seems to be a good idea to expand the number of holdings and include other asset classes and categories.

Neal A. Deutsch, CFP December 4, 2009 at 8:19 am

I read the above blog with great interest: going bottom up, I agree with the author’s comments on giving back: this is what life is supposed to be about – give much, and give often without the expectation of getting anything back.

As a Certified Financial Planner(tm) and financial professional for over 25 years, I find it both dangerous and faulty for those that are untrained in any area of expertise to be giving advice to others, especially an educator. You clearly state that you don’t follow the market daily as you are in your “regular job” focusing on being a better employee, not a better financial professional. Espousing that you “don’t have to watch your stocks every day” is a recipe for disaster – feel free to do it with your money, but don’t preach it to others. Recommending a generic holding period or designing a portfolio without the proper financial planning analytical tools is both foolhardy and dangerous. Would you teach your students part time after your regular job without the proper education and continuing education and accreditation? Do the world a favor…keep your day job and leave the financial planning and investment advisory services to the professionals…

Silicon Valley Blogger December 4, 2009 at 10:17 am

Thanks for your feedback. You are right that we have to be more careful about making “recommendations” to readers. And Tim has cleared up the wording on this article to make sure that this is properly stated. I am very emphatic about saying that this site is used only for information and education (and many times to share my opinions, views and ideas), but ultimately, everyone who visits here should really do their own due diligence and make their own decisions themselves.

I also accept many guest posts on this site as a way to provide fresh perspectives on certain matters. But it doesn’t mean that I agree or endorse those ideas either. The ideas and statements made by guest posters are theirs alone and The Digerati Life may or may not necessarily agree with those statements.

As for “keeping one’s day job” — well, I believe that many investors and financial writers can properly do the same or even better job as many financial professionals if they so chose to get the accreditation for it. I don’t think that there’s any “rocket science” in finance. But I wholeheartedly believe that taking on a purely advisory role should certainly be done only after one acquires the appropriate qualifications for such a position (e.g. take the necessary tests, secure the proper paperwork, etc).

Again — personal financial blogs are really just a way for fans of personal finance to get together and discuss the topics of the day. We don’t tell you what to do, just “what’s out there”.

Silicon Valley Blogger December 4, 2009 at 10:39 am

I’d like to speak more to what Michael is saying in his comment above. The individual portfolio SHOULD BE part of a larger, more diversified long term investment portfolio, in my opinion. At least, that’s what I have done. My personal philosophy is to have a “core and explore” portfolio, where the core portfolio is made up of mutual funds, index funds and such that represent all the major asset classes such as

– domestic equities (stocks)
– foreign equities (stocks)
– bonds
– cash
– real estate
– commodities/precious metals
– foreign currencies (maybe)

And beyond this, I *may* have an “explore” portion of my portfolio, which I simply designate as the place where my “play” money goes. If I have any bucks left over and I want to have some fun and take a gamble or so, I budget for it. Those funds may go to an individual stock portfolio (such as Tim has described above), where I can practice some stock picking. Or they may go to fund some stock trading or option trading endeavors, or perhaps a wild lead on an IPO here in Silicon Valley.

If the “No Hassle Portfolio” is one’s main portfolio, it is not well diversified and is something that could be quite risky to hold, even with dividends earned. I would think this portfolio is used to demonstrate some principles and rules that one investor follows in order to build their individual stock portfolio — but it would be wise to have this individual portfolio as part of a bigger, diversified one that addresses one’s financial plans as a whole.

For more information on my thoughts on portfolios, check out these articles:
On Stock Market Diversification
The Optimal Foreign Investment Allocation
When Beating The Stock Market Is Really An Illusion

Jack Daniels December 5, 2009 at 12:33 pm

Stock investments are the most effective way to make money over the long term, I agree!

John @ Curious Cat Investing Blog December 5, 2009 at 2:03 pm

It is true a small number of stocks can increase the risk. But, often individual stocks are a fairly small percentage of someone’s portfolio. If that is the case some concentration is not too risky. Often 401k’s don’t provide the option for individual stocks – I know mine is that way. Even though people are down on real estate now, many people have large net worth in real estate (which is part of their investment portfolio).

I agree 5 stocks is not a good idea for a substantial portion of someones net worth (say over 20%). I have a portfolio of 12 stocks tracked by marketocracy for over 5 years and the beta is lower than the S&P 500 while the annual return exceeds the S&P 500 by over 500 basis points. But I also would not suggest this for a large portion of my (or someone else’s) total net worth.

A huge factor is also your time frame. If you have only 2 years until you need to use the money. Then stocks is not the right place for that money (individual stocks or mutual funds).

Sherin@Money Hacker December 5, 2009 at 2:35 pm

Nice article! It has exposed all the hidden parts and thought I would mention something I know on this subject: When selecting a stock, an investor should start analyzing any company using following three basic facts:

1. A company should have at least one service or product in a monopolistic position in the market – This will help a company to survive any situations like recession, forcing reduction of price etc…
2. An investor friendly management who value investors money and working for increase investors wealth than self prosperity. Remember why Obama slammed some company managements when they have utilized government given survival package for giving bonuses to its top management instead of utilizing for right things. Such company with inefficient management should be avoided or it lead an investor to hell.
3. Financial status for the company for at least previous 8 years, should be analyzed to know how a company performing and the improvements time to time.

There are various factors involved to analyze prior to invest into a company, but all such factors originally deriving from any of the above three.

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