Imagine you find yourself with a sizeable lump of cash. You’ve decided that you want to use that cash to build a portfolio of defensive shares for both capital gain and dividend income. How could you get started building such a portfolio?
I get asked this question quite a lot because unless you have a system for making buy and sell decisions it’s not obvious where, when or how you get started.
I’ll assume you already understand the basics of the stock market, i.e. that you’re buying (a share of) a company through something called the “stock market”, which is just like a market for anything else whether it’s cars, houses or antiques.
I’ll also assume you have an investment strategy in mind, whether that’s defensive value investing or something else.
Armed with that knowledge, here are a couple of approaches you could use to create your new portfolio:
The fast approach
With the fast approach your goal is to buy all your new investments in one big hit. If you’re looking to offload existing investments which don’t have a single theme or strategy behind them, you would do that first, in one fell swoop.
The fast approach is popular with buy-and-hold investors, and from that point of view I can see the sense in it.
With buy-and-hold there are no on-going buy or sell decisions to be made, other than if one of your holdings goes bust, gets taken over, or otherwise ceases to exist. A buy-and hold investor is typically looking to minimise the amount of time they spend thinking about buying shares, and maximise the amount of time they spend holding them.
But just how fast is fast? What sort of time-scale are we talking about here?
Let’s assume it takes eight hours to fully review a company and come to the conclusion that you want to buy it. Some people might have all day to spend on their investments, but most probably have less than 2 hours in the evening. At that rate it’s going to take four days during the week to review a company, or perhaps a couple of half days at the weekend.
If you’re doing a thorough job of reviewing each investment – thorough enough so that you understand the company well enough to have the faith and belief required to stick with it through thick and thin – then it’s probably going to be hard to buy more than two companies each week.
If you’re looking to hold a diversified portfolio of 30 companies as I do, that’s 15 weeks to build a portfolio from scratch, at the very least.
Of course you could buy 30 stocks in a couple of days. You could even do it in a couple of minutes if your analysis consists of throwing darts at a list of stocks pinned to a dart board.
But if you’re interested in building a good portfolio rather than just any old portfolio, I can’t see it taking less than a few weeks at a minimum, and in most cases a lot more.
So that’s the “fast” approach, where you’re still likely to need a few weeks to put together a solid portfolio. What’s the alternative?
The slow and steady approach
Given that you’re likely to spend a few weeks getting a portfolio set up, why not turn that to your advantage? After all, you’re going to be living with this portfolio for years, and possibly decades, so what’s the rush?
Slow and steady is the approach I would use. That’s because investing is not about making fast decisions, it’s about making good decisions. So what does slow and steady actually mean in practice?
First of all the slow and steady approach means planning out your buying and selling dates in advance.
It could mean, for example, researching companies for an hour or so each evening and coming to a final conclusion at the weekend.
This would limit you to one purchase per week at the most, although I would prefer to go slower than that.
If I had enough cash to create a 30 stock portfolio in one go (which would need to be at least £30,000 in my opinion, so that stock broker fees aren’t an excessive drag on performance) I would probably place one trade every other week. At that pace it would take me more than a year to get fully invested.
There are a few reasons why I prefer this slower approach, mostly because it helps you to be:
- Patient and disciplined – These are probably the two most important traits for investors. The more patient and disciplined you are, the better.
- Alert but detached – A sense of detachment is surprisingly helpful when everything appears to be going wrong with one of your investments. By adding investments just once every two weeks you’re more likely to forget about the stock market on a day-to-day basis, which is usually a good thing.
- Focused on the long-term – Investing really is about years and decades rather than weeks and months, so having a build-up phase that takes over a year is a good way to get used to the idea of thinking on that time-scale.
But the main reason I like this slow, steady approach is that I use much the same process to maintain portfolios after they’ve been built up from scratch.
Unlike buy-and-hold investors, I think portfolios do best when they’re actively worked on, like a garden or a classic car, or essentially anything that degrades over time. And static portfolios do degrade over time.
Some companies will go into decline while some shares will increase in value too fast, reducing their dividend yields. For many different reasons a portfolio that starts out well can falter if it’s left unattended.
So rather than buy-and-do-nothing, I prefer to actively prune my portfolio to keep it in tip top condition. Typically that will mean either selling shares that have increased “too fast” or selling companies that are in long-term decline (which of course I try to avoid by sticking with high quality stocks in the first place).
The process I use to maintaining a portfolio is to methodically trim the fat out every month, selling the weakest link one month and replacing it with something better the following month.
This is a nice, slow and deliberate pace which seems me replacing 20% of the portfolio each year (6 stocks sold out of 30).
It should be relatively easy, both psychologically and behaviourally, to move from a build-up phase of buying one company every other week to a maintenance phase of buying or selling one company each month.
Investing is a marathon, not a sprint
It’s important to pace yourself. If you’re in this stock picking lark for the long haul then you have to pace yourself. Yes, it can be like watching paint dry or grass grow, but that’s okay, you don’t have to watch it.
When it comes to my garden I just pop out on a Sunday, cut the grass and then go and do something else with the rest of my week.
Building and maintaining a portfolio of shares can be done in much the same way.
Ken Brennan says
I like to take opportunities that I perceive that the market offers to me. I often dont do it as well as I could (thats the problem with not being a computer algorithm). I find I do less now that I did years ago but make better returns. There is an element of slowness about it that I am still trying to ascertain properly. As you say its a long term thing.
John Kingham says
Hi Ken, as you say it’s all about taking opportunities. In an ideal world I would make buy or sell decisions at the most opportune time, but I think that there are costs associated with it, primarily around getting too ‘close’ to the market and getting sucked in by the hype. Some people are immune to the noise. I’m not sure that I am so I prefer to protect myself with this pre-scheduled approach.
Also it’s interesting that you mention doing less but getting better returns. That’s a fairly typical outcome which highlights some of the zen-like qualities good investors often have.
Ross Wilding says
John – just to follow that up on that point. Seth Klarman talks about the 80:20 principle in which most of his knowledge (80%) regarding a potential investment is gained in the preliminary research stage. The endless hours after that have diminishing marginal returns to the decision.
Mohnish Pabrai actually suggests that investors (retail and professional) could do a good job by spending just 15 hours/week researching – so much so that he likes to incorporate a nap in his working day!
John Kingham says
Hi Ross, I couldn’t agree more. I actively try to restrict the number of factors that I look at. There are probably only a handful of factors that really matter in any given investment, but if you look at 200 things it’s hard to know which ones matter. I prefer to stick to the 5 or 10 that almost always matter.
And personally I’d aim for 15 hours a month to run a portfolio, especially with the kind of lower risk, multi-billion pound companies I tend to go for. Less (effort) is definitely more (returns) when it comes to investing. I just watched a video with Terry Smith and he said his portfolio turnover in 2013 was effectively zero. So he basically did nothing all year. I don’t go quite that far but it’s certainly doesn’t take a lot of effort if you don’t want it to.
It’s more about doing the right things than doing lots of things.
I’d like to fight the corner of the ‘fast’ approach. All the analysis in the world can’t predict the future share price movements of a particular company. if you’re going for long term investment with FTSE 100, or 250 companies, generally speaking they’re not going to go bust, and there are plenty of websites around to tell you who are the best dividend payers, what the dividend history is, and what a large selection of brokers are currently recommending regarding that company. Use that information, and pick your shares. A couple of hours to ‘analyse’ half a dozen companies, and I will stick my neck out and state that that information is as likely to be right, or wrong as in depth analysis taking several hours – or days – per company! That’s my opinion, and my investing approach and has worked for me, on and off, over the last 30 years.
John Kingham says
Hi Laurence, I think you make a pretty valid point there. The market is very efficient and any representative group of 20-30 leading stocks, say from the FTSE 100, is likely to perform in quite a similar manner to the wider market, and therefore such a portfolio can be built in a relatively short time, or even “instantly” if you just want to buy a list from a quantitative screen. I know that’s what a lot of people do with the HYP-type portfolios.
I think that’s fine if a) you don’t expect to beat the market and b) don’t expect to actively maintain the portfolio. But in my case I do expect both of those things, which is why I prefer this slow build up approach and more detailed analysis.
If I was only going to spend an hour or two in total to analyse 30 companies I think I would probably not bother at all and just buy the index. But your approach is totally reasonable, it’s just halfway along the passive/active continuum between index tracking and what I do.
As long as you have a plan and stick to it, and it works for you, that’s probably the most important thing.
Milind Bhagwat says
I see a problem when investing in a bull market. I can find a number of companies that will deliver a good dividend but are being sold at a high price at the moment. What is your advice for investing in a bull market?
John Kingham says
Hi Milind, I think there will always be pockets of value even in the biggest bull markets. Of course that value will be less than during a bear market, but not so much that I’d switch to cash. My approach is to stick with buying good companies at low or fair prices and focus on the long-term. Having said that, the downside risks during a bear market are higher, but I think the opportunity cost of moving into cash during a bull market and are even higher.