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Thursday, April 22, 2010

How to create a Stock Portfolio?

A portfolio is a group of financial assets such as stocks and bonds, held by an investor. In today's financial marketplace, investors need to create well-structured portfolios that suit to their investment goals and strategies. There are investors who are risk-takers and investors who are risk-averse. Constructing a portfolio that reflects the investor's risk profile and tolerance is a key factor for effective investment decision making.

Clarifying current situation and future needs for capital, along with risk tolerance determines the asset allocation among different asset classes. Optimal asset allocation is an effective method of diversification. Investors should diversify between different classes of assets but also, within each class. This allows them to incur long-term investment growth, while their assets are protected from the risks of large declines and structural changes in the economy over time.

Another important factor to be considered when constructing a portfolio is the stock volatility. Typically, market fluctuations are subject to interest rates changes, inflation, political turbulence, corporate news etc. Investors should keep an eye both on current developments and broader socio-economic environment and on historical data as these reflect a stock's past performance and assist to a fairly accurate assessment of future performance.

Financial ratios are also important when constructing a portfolio. Price/earnings (P/E), Book value (BV), return on equity (ROE) and total return indicators are highly important tools to assess liquidity, profitability, leverage, capital structure, and interest coverage. Although ratios reflect historical data and past performance, they can also predict future potential and provide lead indications of potential trouble areas.

Optimal portfolios provide the highest possible return for any specified degree of risk. To that end, they need to be revaluated on a regular basis in order to reflect new market realities. Investments should be regularly analyzed and investors should perform reallocation of their portfolio if required.

Finally, investing at regular intervals is a good method to build wealth. Both, risk-takers and risk-adverse investors can smooth out market fluctuations, through rupee-cost averaging that is investing a fixed amount on a regular schedule. This fixed amount automatically buys more shares when prices are low. Consequently, the average purchase price of the stock is lower than the average of the market prices over the same length of time. Although, Rupee-cost averaging does not automatically produce a profit, still by investing on a regular schedule virtually guarantees to do better in a generally rising market than investors who try to time market highs and lows.