Systematic investment, an effective way to build wealth

Investing in the stock market can be an unbelievable way to generate wealth over a period of time. Even as, there are many individuals who refrain from investing in the stock market because they believe it’s too dangerous.

On the contrary, systematic investment in stock markets can be one of the most effective ways to build wealth.

Of course, one should be smart and should take the time to study the most favourable ways of investing. Remember, making money can be a short-term process, but creating wealth only happens in the long -run. Creation of wealth is a product of patience and knowledge. Building up well-maintained portfolio is important to any investor’s success to create wealth.

As an individual investor, one needs to know how to determine asset allocation that best conforms to your personal investment goals and strategies. In other words, your model portfolio should meet your future needs for capital and give you peace of mind. This is regardless of whether you own a dozen companies or a hundred in your equity portfolio.

Of course, there are several elements that go into making an ideal or model portfolio, which takes care of your returns over a period of time.

Important  factors that need to be considered include your age, how much time you have to grow your investments, the amount of capital you want invested and future capital needs. Creating an ideal portfolioMost successfully followed  rule for equity allocation is 100 minus your age. For instance, my age is 35, and then typically, 60-65% of my investible funds are in equities at any given time.

Building a robust portfolio, which preserves a balanced temperament during turbulent markets is not out of reach for the individual investor.

Start your research by zeroing in on the industry / sector in which you want to invest (FMCG, technology, electronics, chemicals, etc.). Within this sector, select companies on the basis of their size (i.e. market capitalisation) and / past Return on Equity (ROE) record. You can use one of the many tools to find companies based on industry/sector, market capitalisation and on the parameters of profitability and growth ratios etc. You can make a list of stocks for further research based on these parameters.

How to maximise returns

As a thumb rule, the generally followed principle is to invest around 50% of the portfolio in blue-chip or well established companies, then another 25% in upcoming mid-caps and the balance in small lesser known companies.

One should aim to minimise risk in each individual stock and always invest in companies with a lower cash-flow payback period.

Financial position or balance sheet of each company should be such that it has a capacity to survive high levels of financial and operating adversity caused by unanticipated changes.

The real challenge of building up a portfolio is to maximise earnings over the holding period. Your goal as an investor should simply be to purchase, at a rational price in an easily understandable business whose earnings are virtually certain to be materially higher five, 10, and 20 years from now.

Over time, you will find only a few companies that meet these standards—so when you see one that qualifies, you should buy a meaningful amount of stock. If you are looking for long-term investment stocks, once you select a set of companies based on whatever your consideration may be (i.e. market capitalisation, CAGR in profit, risk of investment vis-à-vis return, etc.) — five to 10 is the maximum number of stocks you should be actively holding at any given time.

Sure, you can diversify and add more stocks in your portfolio, but if you can’t get it right, you will get a similar result with holding 15, or even more.

(The writer is CEO of Broking and Distribution Business, Reliance Capital)