Follow these golden rules

Whether you have $5000 or $1 million to invest, a carefully constructed portfolio is the key to success on the stockmarket

Over the past 20 years I have met thousands of people who want to learn how to trade the stockmarket and one of the most common questions I get asked is how to construct a portfolio with different amounts of capital.

Obviously the amount you have to invest will determine how you initially construct your portfolio. But when it comes to constructing a portfolio, many believe it is all about finding stocks that have the potential to rise rather than establishing the solid foundations. Indeed, to be truly successful in the stockmarket, investors need a practical framework that will allow them to select stocks with a higher chance of ensuring they are consistently profitable. Therefore, what follows are four golden rules that I outline in my new book, Accelerate Your Wealth, which I believe you need to consider when investing in the stockmarket so as to reduce risk and ensure your long-term success.

Golden rule No. 1

Irrespective of the amount of money you have to invest or the instrument you are trading,

you should always spend the same amount of time researching your options to ensure you are protecting your capital on each and every occasion.

Golden rule No. 2

When constructing a medium- to long-term portfolio, you should always aim to have between five and 12 stocks. The idea is not to have lots of stocks with small amounts invested in each. Instead, you only require a small number of the right stocks with larger amounts invested in each.

Golden rule No. 3

Never invest more than 20% of your total capital in any one stock. You need to accept that some stocks will fall in value. However, this rule will help reduce your exposure to risk while allowing you to achieve good returns simply because you are minimising the amount of capital you could lose at any one time.

Golden rule No. 4

You should only ever invest 10% of your capital in trading volatile, short-term or highly leveraged markets and allocate the remaining 90% to trading a medium- to long-term portfolio. This is a very solid money management rule that allows you to take a low-risk approach with your money while still achieving good returns on your capital.

Now that we have looked at the four golden rules for success in the stockmarket that will help you accelerate your wealth, let’s see how you would initially construct your portfolio based on the amount of capital you have to invest.

Small investors

Because of transaction costs, I always recommend that the minimum amount you should allocate to a particular stock is $1000, although you will want to develop a savings strategy so that you can build up your portfolio until you hold at least five stocks.

Obviously, if you have less than $5000 to invest, you will be breaking rule No. 3, which is OK in the short term because, for many, it is the only way they can get started. Once you hold a minimum of five stocks, you can begin to increase the amount of shares you hold in each company.

Small investors tend to focus on buying small volatile stocks based on the false assumption that they are getting better value than they would if they purchased large blue-chip stocks. But in my experience, the opposite rings true. When starting out, it is wise to invest in the top 20 stocks on the market, such as the banks, BHP, Wesfarmers, Telstra and CSL, as these are safer and more likely to deliver a solid return.

Investing in the stockmarket is not about how much you make; it is about how much you do not lose over time. In getting started, you not only need to build your capital base but, more importantly, you need to build your knowledge and experience. Therefore, investing in the top 20 stocks will help you to achieve this as you won’t be worried about losing your shirt by speculating in small volatile stocks.

Small to medium investors

If you have between $5000 and $20,000 to invest, you may still need to break rule No. 3, particularly if you have less than $10,000, as you want larger parcels of your capital invested so as to minimise your risk. If you have $10,000 to $20,000 to invest, you would comfortably be able to follow rule No. 3.

I recommend that you invest a minimum of 60% in the top 50 stocks weighted to the top 20 with the remaining 40% invested in other stocks out to the top 100. This will enable you to underpin your portfolio with solid performers like BHP, Cochlear, CSL, Lendlease and the banks, while the remaining 40% would be invested in great performers that are more volatile, such as A2 milk, Bellamy’s, Caltex, Oil Search, ResMed and the like.

The trick is to have some volatility in your portfolio, although you do not want too much, as it becomes too stressful to manage.

Larger investors

If you have more than $20,000, you will be able to hold more than five stocks. For example, if you have $100,000, you may want to purchase 10 stocks, with each representing 10% of your total portfolio, and if you have $1 million to invest, you may want to invest $100,000 in each stock.

I recommend you invest at least 90% of your total portfolio in the top 100 stocks on the market. For most people, selecting stocks from the top 100 will ensure you have a great performing portfolio that is easy to manage and low risk, as there is plenty of choice and the stocks are highly liquid.

Investing outside the top 100 will dramatically increase your risk and the workload needed to manage this risk, which is why I recommend you invest no more than 10% of your total portfolio outside the top 100. Once again, I recommend you invest 60% in the top 50 to underpin your portfolio with good trending stocks that consistently perform well over time. With the other 40%, you may want to invest 30% in stocks out of the top 100 and the remaining 10% in stocks out of the top 200.

If you decide to invest outside the top 100, you still need to look for liquid stocks that trade at least $5 million to $10 million a week, such as Vocation, Jumbo Interactive and TechnologyOne.

Know when to sell

From experience, if you follow the golden rules and strategies outlined in this article and in my book, you will reduce your risk and achieve greater returns than most stockmarket investors.

If you want to achieve better returns, it is important that you focus your attention on educating yourself on how to do this. Simply buying a stock because it looks good doesn’t cut it.

You need to have a solid process and purchase assets that are rising in value and increasing your wealth, because while it is important to know when and how to buy, it’s even more important to know how and when to sell.