Putting the rules and commandments into action – building a discretionary portfolio

Putting the 10 commandments of trading and the 25 rules of investing into action is where the rubber meets the road proverbially. You’ll either make or lose money dependant on what you do. With this in mind, there are a few ground rules which if you aren’t willing to obey you’d be far better off putting your money into a mutual fund.

The basic ground rules for building your own discretionary investment portfolio are:

1. Remember it’s buy-and-homework rather than buy-and-hold – so you can’t buy any stock unless you commit to doing at least one hour’s research on that stock every week while you own it.
   
   
2. You must be interested in the business and not just the stock price – that is, you must want to find out what makes the business tick and follow its key metrics before you can invest in a stock. If this sort of detail bores you to tears, let someone else manage your money.
   
   
3. You must have a friend or adviser you can bounce ideas off – someone who will be blunt enough to tell you when your rationale for doing something is ridiculous.
   
   
4. You must look at investing as an endurance race rather than a sprint – and therefore you must be willing to stay out of the market for long periods of time and keep your discretionary money in cash if this is the most sensible thing to do. You also need the discipline to stick with it.
   
   
5. Once you buy a stock, you have to put out of your mind all the reasons why you purchased – and focus instead on where you think the stock price is headed from this point forwards. Ignore all the feelings that made you buy the stock in the first place and look at the facts that will determine where it heads in the future. Make buy and sell decisions on the basis of current facts, not your history with that stock.
   
   
6. Always differentiate between what a stock is worth and what price the stock is selling for at the moment – because the two are not always in sync. This simple approach should allow you to spot stock moves before they happen since over a long period, the price will end up matching the underlying value – unless there are very good reasons why not.
   
   
7. Remember, job one is to stay in the game – and therefore you shouldn’t do anything unethical, illegal or downright silly. Don’t pick stocks that can wipe you out if unanticipated glitches arise. Don’t borrow money to invest in the stock market. Don’t expect anyone else to do your investment homework for you. Don’t buy more of bad stocks so you can average down your purchase price. Don’t get discouraged or fed up or desperate when times get tough and the markets are slow. Remember that over the long term, stocks have always outperformed all other asset classes so stay involved long enough to take advantage of this fact.
   
   
8. Never forget stocks are just pieces of paper – and there will be times when emotion rather than logic is driving the price of stocks. At those times in particular, you’ll need to open your eyes, think for yourself and act in a disciplined way rather than getting swept along on waves of emotion. If you can keep your head when others are panicking, you’ll do just fine in investing and trading.

Now keeping the ground rules in mind, to build a genuinely diversified portfolio, you’ll need to buy stock in a minimum of five different companies. The five must-haves are:

1. A local company – some company you know well, relate to personally and a company that employs people within your circle of friends. This will be the sort of company where you can visit and get a feel for how things are going firsthand. If the company has a local store, go there and just hang out often to get a sense of how the business is going.
   
   
2. An oil stock – because these have been one of the most consistent performers. Oil stocks have high dividends, great cash flows and a business model that works well even in downturns. What more can you ask for as an investor?
   
   
3. A brand-name blue chip – something that is currently selling at a 2.5-percent yield or higher. If you can’t think of anything else, look for a major chemical company or conglomerate.
   
   
4. A financial services company – a bank, an insurance company, a savings and loan. These companies make up a major proportion of the S&P 500 and have performed consistently well over a long time.
   
   
5. A speculative investment of your choice – something that you just have a hunch will make it big. Be realistic, and acknowledge that this part of your portfolio will either perform spectacularly well or bomb entirely and don’t worry. As long as you adhere religiously to the concept of dedicating no more than 20-percent of your portfolio to a purely speculative investment, have an adventure.

Remember diversification is designed to ensure you do well irrespective of what happens in the broader economy as a whole. To achieve this, you need a minimum of five stocks. You’d want to have at least $2,500 invested, a minimum of $500 per stock held. If your pool of investment capital is smaller than that, it will probably be better for you to put that money into a mutual fund. There’s just too much homework required in maintaining a diversified portfolio to make it worth your while for less than $2,500 worth of stock. Equally, if you don’t genuinely have enough time available to devote at least five hours a week to maintaining your portfolio, invest in a mutual fund and focus on whatever else you have going on in your life. Buy-and-homework is much harder than buy-and-hold.

If you do have the money, time and inclination to invest further, you can keep adding to your minimum portfolio by buying stock in these types of companies:

1. A consumer products company – like Procter & Gamble, Kelloggs, Colgate, etc. These stocks are long-time performers. Buy when they are out of fashion and wait for these companies to snap back. They always do.
   
   
2. A cyclical company – whatever is out of phase in this part of the economic cycle. You should be buying industrials or smokestacks when everyone is saying how bleak their outlook is, and so forth. A little bit of contrarian investment here can generate impressive gains when the economy changes.
   
   
3. A technology company – which will be a high-risk investment. If at all possible, find a tech company that pays a yield – that means they are mature enough to be steady growers.
   
   
4. A young retailer – something that is currently regional and which looks likely to go national in the near future. Retailers that have shown they work in one area and are about to expand can be a great investment. Your ideal here is to try and catch the next Gap, Home Depot or Wal-Mart.
   
   
5. A nontech stock which is your “hope for the future” – some young company which have the credentials to turn out to be big further down the road.

Don’t forget that when you’re buying or selling shares for your discretionary portfolio, spread the transactions out rather than doing them all at once. This lets you take advantage of any momentary blips which crop up in the marketplace all the time.

To maintain your portfolio, you should rank your stocks every Friday on a scale of 1 to 4. A 1 is a stock you would buy more of today if you have the capital available. A 2 is a stock you would like to buy if its price came back by 5-percent or so. A 3 is a stock you already own which you would be willing to sell if it went up by 5-percent or so. And a 4 is a stock you want to get rid of as soon as possible. By making this ranking each week, you’re prepared to act quickly if anything dramatic happens in the marketplace. Ranking lets you turn your fears into a method of buying stocks on terms you like and selling them on the terms you want rather than letting the market dictate.