Your Money: How to choose a winning portfolio of stocks

August 24, 2020 1:30 AM

The universe of equity investment can safely be narrowed down to just 30 stocks in case of Sensex or 50 in case of Nifty 50

As of today Sensex, Nifty and the majority of their constituent stocks have recovered most of their value after the market crash in March due to Covid-19.

By Parthajit Kayal & Janani Sri SG

Investors find it comfortable to put their money in mutual funds as it is managed by fund managers. It may be overwhelming for retail investors to identify suitable stocks to invest when there are around 5,000 stocks traded in India. Nevertheless, it’s never an easy job to find the right mutual fund schemes when there are about 2,500 schemes. Moreover, only about 20% of these managed to perform better than the benchmark indices over the last 10 years. Therefore, investors are more likely to choose the wrong funds and end up getting less return than what Nifty or Sensex could generate.

Choosing right stocks may not be difficult

As it appears that investors may be better off choosing low-cost index funds than breaking their heads finding right mutual funds for themselves, the universe of equity investment can safely be narrowed down to just 30 (in case of Sensex) or 50 constituent stocks (in case of Nifty 50) of major equity indices. Large size, long history of existence, high brand value, etc., make these stocks relatively less risky in general when compared with stocks that are not part of these indices.

As of today Sensex, Nifty and the majority of their constituent stocks have recovered most of their value after the market crash in March due to Covid-19. However, only very few of the mutual fund schemes are able to catch up. These mutual fund schemes are bearing the brunt of over-diversification. By investing in individual stocks over-diversification hiccups can be taken care of and can be made to cater to personal needs. It also gives a lot of flexibility to the investor to time his purchase or sale of stocks.

Forming the right portfolio

Constituent stocks of the indices are from different sectors. Retail investors can pick 15 to 20 stocks out of them across the sectors to design their own portfolio. Focusing on stocks from essential sectors such as FMCG, pharmaceuticals should be the first choice. For investors who have started investing in the later years of their career, blue-chip stocks have shown to provide consistent returns in about 5-6 years and it may be easier to achieve that from such stocks than mutual funds.

For appropriate diversification, investors could choose major players from the IT industry, private banks and other non-banking financial institutes. It may be wise to avoid stocks from public sector units due to their efficiency and corporate governance issues.

Putting together a portfolio of stocks offers a chance at customisation— you can choose to include a whole lot of companies of your preference or avoid a set of companies as well. Investing through mutual funds, investors will have no say over the underlying holdings of the fund. Therefore, instead of picking a one-size-fits-all mutual fund, investing in a personalised portfolio suiting individual financial risk targets, keeping in mind the investor’s life goals as well, is probably a better option.

Kayal is assistant professor, Madras School of Economics & Janani is researcher, IIM Bangalore

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