How To Build A Winning Stock Portfolio: A Step-By-Step Guide For Beginners

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So, how do you build a good stock portfolio from scratch?

As an investor, you probably understand that investing is more than just buying stocks.

To be a successful investor and grow your wealth in the long term,  the key lies in building a good and diversified stock portfolio.

So, what actually makes a good stock portfolio?

How exactly do you build a stock portfolio from scratch if you are a beginner investor?

Also, how do you protect your stock portfolio from events such as recessions?

Lastly, what are some examples of good stock portfolios?

What Is A Stock Portfolio?

So, what is a stock portfolio?

And why is building a stock portfolio so essential to your investing success?

A stock portfolio is simply a collection of financial assets such as stocks, bonds, gold, exchange-traded funds, mutual funds, and cash.

When it comes to building a stock portfolio, you need to understand an important concept called “diversification”.

So, what is diversification?

Diversification means that you spread your money across different types of investments with little or no relations to each other. 

Why do you want diversification in your stock portfolio?

Because you don’t want to put all your eggs in one basket, and diversification can help you reduce your investment risk.  

Let me give you an analogy. 

When you were young, you were told that to be healthy and strong,  you need to eat a balanced meal that includes grains, dairy, meat, vegetables, and fruits.

Each type of food has its own unique benefits to your body.

Together, it gives your body all the nutrition it needs. 

But, if you eat just one type of food or totally avoid eating a single type of food, your health will likely suffer in the long term. 

Similarly, you need a balanced investment portfolio to reap benefits from different kinds of market conditions as well as protect you from various adverse market conditions. 

So, what are the different kinds of market conditions?

As you probably know, different market conditions result in these different stock market movements (or trends).

Below are the 3 different types of market trends:

• Up 
• Down
• Sideways

When the economy is growing steadily (or even rapidly), the stock market would generally go up.

But, when there is a recession, the stock market would usually go down.

So, economic growth is one of the most important market conditions that you need to look at.

As you probably know, the economy is NOT guaranteed to do well all the time.

That’s why you need to be prepared for adverse market conditions that could negatively impact your stock portfolio.

Here are some examples:

• Economic crisis (e.g. 2008 financial crisis)
• War
• Pandemic (e.g. Coronavirus Crisis)
• Terrorist Attack (e.g. 911 terrorist attack)
• Hyperinflation

To protect your stock portfolio from adverse market conditions, the only way is to build a diversified stock portfolio.

Here’s why.

When the economy is not doing well, gold investments would generally perform better than other types of investments.

On the other hand, when the economy is doing well, stocks would perform much better.     

By allocating your money into diverse types of investments, you can reduce the volatility of your stock portfolio (i.e. your risk).

How to Build A Winning Stock Portfolio 

Generally, to start building a stock portfolio, you will need to first determine the following things:

• Size of your stock portfolio 
• An investment strategy based on your investment objective and risk profile
• Portfolio mix (i.e. asset allocation)

Now, let’s look at it one by one. 

Step 1: Portfolio Size

How big a stock portfolio are you planning to build?

A $100,000 stock portfolio?

Maybe a million-dollar stock portfolio?

How much do you have to invest at the beginning?

$1,000, $10,000 or maybe $100,000?

Are you planning to keep adding more money to your stock portfolio on a regular basis?

If yes, how much and how often do you think you can add to your stock portfolio?

$1,000 every month?

Or $10,000 every year?

All this completely depends on your unique financial situation as well as your long-term financial objective.

So, what is the general rule here?

The earlier you start investing, the better.

Because you can put the power of compounding to work in your favor sooner.

Below is the graph to show you how investing early can help you grow your wealth much much faster.

As you can see, investing earlier and staying invested longer makes a HUGE difference in your wealth.

Step 2: Choose an investment strategy for your stock portfolio

Next, you need to choose an investment strategy based on your investor’s profile as well as your investment objective.

So, what type of investor are you?

Are you a hands-on investor who wants to picks stocks for your portfolio based on your own stock research and analysis?

Or are you an investor who does not have time to do your own stock analysis?

Also, there is always a risk that comes with investing. 

So, when it comes to risks, are you risk-averse, or are you comfortable with taking some risks?

Depending on your investor profile, you can choose an investment strategy as well as an asset allocation that suits you.

Next, let’s take a look at your investment objective.

So, what is your purpose for building a stock portfolio?

Are you investing for the long term to build a sizable retirement fund?

Or are you investing for consistent income?

Or are you trading for quick short-term profit?

Depending on your investment objective, your investment strategy will be different.

There are many different types of investment strategy:

• Value investing strategy (i.e. buying undervalued stocks for price appreciation in the long term)
• Dividend growth investing strategy (i.e. buying dividend stocks or REITs)
• Passive investing strategy (i.e. buy ETFs or mutual funds)
• ESG investing strategy (i.e. invest in companies that are socially responsible)
• Short-term trading (i.e. make quick gains in the short term)

So, what investment strategy is right for you?

Let’s say that you are an active investor who wants to pick value stocks based on your own stock analysis and add to your stock portfolio for long-term investments. 

Then, value investing strategy will be a good fit for you. 

On the other hand, if you are a passive investor who does not have time to do your own investment research, then passive investing strategy will be more suitable for you. 

Now, what if you are investing for income?

Then, dividend investing will be right for you. 

For example, there are a group of stocks called “Dividend Aristocrats”.

They are S&P 500 index constituents that have increased their dividend payouts for 25 consecutive years or more.

Here are just a few of Dividend Aristocrats:

• AT&T
• Johnson & Johnson
• 3M
• Mcdonalds’
• Coca-cola
• Clorox
• Walmart
• P&G

Lastly, if you are an active trader who wants to make a profit from the short-term price fluctuation in stocks, then short-term trading strategy will be more suitable for you.

Step 3: Portfolio Mix (i.e Asset Allocation)

Once you have determined your investment strategy, it’s time to work on your portfolio mix.

Here are some of the common questions you might have:

• What should your portfolio consist of?
• What is a good portfolio mix?
• What is the ideal number of stocks in a portfolio?
• How much cash should I have in my portfolio?

We will address these questions one by one.

So, what should your portfolio consist of?  

Stocks?

Bonds?

ETFs?

Mutual funds?

Gold?

To decide which investment asset class you want to include in your portfolio, you need to first know the following:

• Correlation between the asset classes (i.e. are they highly correlated? Meaning when one goes up, the other one usually go up as well)
• Historical investment return (i.e. how well does it perform in terms of returns? average 10% a year or much less?)
• How volatile is it? (i.e. does its price fluctuate a lot? higher volatility means higher risks)
• Is there a minimum investment required? 

Now, let’s go through it one by one.

Generally, stocks and bonds are negatively correlated.

Also, gold is usually negatively correlated with stocks, and is typically used as a hedge against the stock market during economic recessions.

Now, what about historical investment returns?

This is quite important because the reason why you want to invest is to grow your money.

Historically, the stock market has averaged about 10% per year since 1920s.

But, that is not to say that the stock market would give you a 10% annual return every single year!

In some years, stocks might do worse (e.g negative returns), while in other years stocks might do very well (e.g. well above 10%).

By staying invested for the long term, your investment returns in the stock market would be smoothed out. 

Now, let’s look at the bond market.

The average annual return for long-term government bonds (e.g. 10-year bond) is about 5% since 1920s.

Below is the performance comparison in dollar terms. 

Let’s say that you invested $1 into “small-cap stocks”, “large-cap stocks”, “government bonds”, “short-term 3-month treasury bills” respectively at the start of 1926.

So, how much would your $1 be worth now?

Your $1 in “small-cap stocks” would be worth more than $32,000, whereas your $1 in “large-cap stocks” would be worth about $7,000.

On the other hand, your $1 investment in “long-term government bonds” would be worth about $140, whereas $1 in “short-term treasury bill” would be worth about $21.

As you can see from the performance comparison above, the stock market has historically generated much higher returns compared with bonds and treasury bills.

In particular, small-cap stocks have also performed better than large-cap stocks. 

This is because there is still much more room for growth for small-cap stocks. 

If you are interested in investing in good high growth stocks, I highly recommend that you check out David Gardner’s stock picks.

Having said that, higher returns also come with higher risks (i.e. volatility in prices).

When you compare volatility, you want to look at metrics like:

• return in the worst year (i.e. comparing the maximum loss)
• return in the best year (i.e. comparing the maximum gain) 
• how many years of negative returns
• standard deviation (i.e. how much does it deviate from the average or the norm? the higher the standard deviation, the more volatile it is)

Below is a table that summarizes the risk comparison between stocks and bonds from 1926 to 2018:

From the above, you can see that stocks are generally more volatile than bonds.

Now, let’s summarize.

So far, you know that stocks have historically performed better than other asset classes.

Also, stocks are more volatile and risky than bonds. 

So, what should your portfolio consist of? 

If you are serious about growing your wealth, you should definitely include stocks in your portfolio.

Bonds are good to include because it is less risky and helps you reduce your overall portfolio volatility.

Gold is also good to have in your stock portfolio.

This is because gold can act as a hedge against the stock market and also protect your portfolio against an economic recession.

Now, it brings us to the next question.

What is a good portfolio mix?

100% stocks?

100% bonds?

50% stocks and 50% bonds?

60% stocks, 30% bonds and 10% gold?

So, which is the right portfolio mix for you?

This depends on your profile and your long-term financial objective.

Let’s say you are single and young and want to grow your wealth for the long-term.

Also, you are comfortable with taking risks. 

Then, a much bigger percentage of your portfolio could be allocated to stocks (e.g. anywhere from 50% to 100%)

Now, what if you are in your late 30s and married with kids?

Your long-term investment goal is to build a sizable retirement fund.

As you have a family to take care of, your risk tolerance level is not high. 

In this case, you might want to have a good percentage of your portfolio allocated to bonds (e.g. anywhere from 30% to 70%)

Ideally, you might want to have a very small percentage of your portfolio invested in gold.  (e.g. 5% to 10%)

Why a small percentage?

This is because the gold market is more volatile than bonds.

And it is just as volatile as stocks, if not more so.

In terms of historical returns, stocks still do much better than gold.

To build a stock portfolio completely customized to your unique financial goals and preferences, I highly recommend M1 Finance.

with M1 Finance Custom Pies, you can choose from any individual stocks, stock ETFs, bond ETFs and gold ETFs to build your ideal long-term portfolio for FREE.

Here’s the best part.

If you don’t have the time to build your portfolio,  M1 Finance provides about 100 Expert Pies (i.e. pre-designed expert portfolios) for you to choose from based on your financial goals, risk tolerance, and time horizon.

Better still, it helps you automatically re-balance your stock portfolio to maintain your pre-defined portfolio mix.

Now, how many stocks should you include in your portfolio?

100?

20?

Or 10?

The more stocks you buy, the more diversified and less volatile your stock portfolio is.

But, with more stocks, it also reduces the overall portfolio returns.

So, there is a trade-off you have to consider between risk and returns.

Ideally, you should have 1o to 25 stocks from diverse industries in your portfolio. 

For stocks, some stocks are highly correlated while others are not.

So, how do you tell what stocks are highly correlated?

For example, there are defensive stocks such as Consumer Staples stocks (e.g. P&G, Coca-Cola) and Utilities stocks (e.g. Sempra Energy, American Water Works, etc).

These defensive stocks would generally hold up well during economic downturn, but defensive stocks generally underperform the broader market.

There are also cyclical stocks that are strongly affected by the cycles of the economy.

When the economy is doing well, these stocks tend to do very well.

But, when the economy is doing poorly, these stocks tend to fall sharply.

Here are some examples of cyclical stocks:

• Luxury goods ( e.g. Tiffany, Ferrari, Burberry, LVMH, etc)
• Hotels (e.g. Hilton, Marriot, etc)
• Apparels (e.g. Lululemon, Gap,  Nike, etc)
• Airlines
• Financial services
• Real Estate (e.g. REITs)

Lastly, you have sensitive stocks that are moderately correlated with the economic cycles. 

This group of stocks generally come from the following sectors:

• Communication services (e.g. Verizone, Comcast, etc)
• Technology (e.g. Apple, Google, Microsfot, etc)
• Industrials (e.g. 3M, GE, Boeing, Honeywell, etc)

As a general rule, you should never buy stocks from just one single sector or industry.

Just imagine that if you’ve bought just airline stocks or hotel stocks for your stock portfolio, then you would see a huge drop in your portfolio value because of the Coronavirus crisis. 

If you want to have diversification without having to buy too many individual stocks, here’s a way to do it – invest in ETFs.

An exchange traded fund (ETF) is a type of security that involves a collection of securities—such as stocks—that often tracks an underlying index.

For example, let’s say that you want to invest in the technology sector.

Instead of buying individual healthcare stocks, you can buy technology ETFs.

The same goes for other industries.

For example, if you want exposure to defensive stocks, you can buy defensive stock ETFs.

Lastly, what about cash?

How much cash should you hold in your portfolio?

The general rule is that ideally you should stay fully invested for as long as possible to take advantage of the compounding effect.

Cash gives you the LEAST return of all the asset classes. 

In fact, you are losing money due to inflation by holding cash.

If you really cannot find good investments, then the very least you should do is to put your cash in an interest-earning account.

For example, I am using M1 Finance to earn interest on any cash that is not invested yet.

Step 4: How To Find Stocks For Your Portfolio

Once you have determined your ideal portfolio mix, the next step is to find stocks to invest in.

Back in Step 2, you have chosen an investment strategy for your portfolio.

Just to recap, here is a list of popular investment strategy that we’ve gone through:

• Value investing strategy (i.e. buying undervalued stocks for price appreciation in the long term)
• Dividend growth investing strategy (i.e. buying dividend stocks or REITs)
• High growth stock investing strategy (i.e. buying stocks that can potentially go up by 10 times or more)
• Passive investing strategy (i.e. buy ETFs or mutual funds)
• ESG investing strategy (i.e. invest in companies that are socially responsible)
• Short-term trading (i.e. make quick gains in the short term)

Depending on your profile and financial goals, you can choose an investment strategy that suits you the best.

Of course, you can also mix and match these different investment strategies.

Personally, I include value stocks, dividend stocks as well as high growth stocks in my stock portfolio.

So, depending on your unique situation, you might choose differently.

Let’s say that you are a young investor and want to grow wealth and invest for the long term. 

In this case, you might want to buy value stocks as well as growth stocks.

Or, you might want to pursue a dividend re-investing strategy where you invest in high-quality dividend stocks and reinvest the dividends every year.

Or you might want to just invest in stock market index ETFs such as S&P 500 ETFs if you don’t have time to pick your own stocks.

So, there are many different ways to build your stock portfolio.

On the other hand, let’s say you are nearing retirement age and you want a portfolio that can generate income for you.

Then, you might want to invest in high-quality dividend stocks.

Or you might want to invest in REITs.

Or you might want to invest in high-quality and low-cost dividend ETFs.

If you want to do your own stock research and analysis, then I highly recommend Stock Rover which is a very powerful stock analysis platform.

Personally, I use Stock Rover to screen the stock market and find good stocks and ETFs for investment.

Step 5: How To Manage Your Stock Portfolio

The last step is portfolio management. 

Why is this important?

This is because stock price keeps changing all the time.

What this means is that your pre-defined asset allocation would change.

To maintain the same asset allocation, you will have to regularly rebalance your stock portfolio.

For example, you own 20 different stocks in your portfolio, with a targeted weighting of 5% each. 

Some of the stocks will go up while other stocks might go down. 

To maintain the targeted weighting of 5% each, you will have to sell some of your winning stocks and buy more of your losing stocks.

If you are actively managing your portfolio yourself, then I highly recommend “Stock Rover” to help you management your stock portfolio.

Inside Stock Rover, you can use its portfolio tracker and portfolio management tools for FREE.

Here’s how you use Stock Rover to analyze, re-balance and manage your stock portfolio.

First, it allows you to connect your Stock Rover account to your broker directly with a few clicks, so you can always see the most updated version of your portfolio.

Once your account is synced, you can use its “Trade Planning and Rebalancing” tool below.

With this powerful tool, you can easily know how many shares you need to sell or buy for each stock in your portfolio to maintain your ideal asset allocation.

Now, what if you are building a stock portfolio for income, Stock Rover has a very useful tool to help you project future income from your portfolio.

With this Stock Rover‘s Future Income tool, you know exactly how much income you are getting from your stock portfolio every month.

Lastly, Stock Rover also allows you to analyze the correlation between stocks in your portfolio.

This is super useful because you don’t want to build a stock portfolio where stocks are all highly correlated with each other (i.e. not diversified)

So, how do you tell how correlated two stocks are?

• “1” means they are perfectly correlated. If one moves up 10%, then the other also move up 10%.
• “0” means they are completely uncorrelated. One stock’s price movement has no relationship with the other stock’s.
• “0.5” means they are moderately correlated. 

With Stock Rover‘s correlation table, you can easily check if your stock portfolio is diversified or too concentrated.

But, if you are too busy to monitor and manage your stock portfolio, then I would highly recommend M1 Finance which is a very powerful robot-advisor that helps you automatically rebalance your portfolio for free.

Summary

Building a diversified stock portfolio is the key to manage the risk of your investment. Depending on your investor’s profile as well as personal financial goals, you should always choose an investment strategy and portfolio mix that best suits you.