Basics of Investing & Portfolio Management

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Security Selection

lesson 5

Duration: 3 minutes

In this section, we will continue developing the foundation of how to build the perfect portfolio. We will learn what security selection is and we will examine the three best paths one can take to get a great portfolio.
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Security Selection

In this section, we will continue developing the foundation of how to build the perfect portfolio. We will learn what security selection is and we will examine the three best paths one can take to get a great portfolio.

What is Security Selection?

It is simply the actual process of choosing the investment assets that you will purchase and hold in your portfolio. This step is crucial in creating the perfect portfolio. The key to finding the right securities for your portfolio is simplicity, consistency and a long-term mindset.

If done correctly, security selection can help you reach or even exceed your goals. However, it can be dangerous because it is easy to deviate from the process and the strategy and end up making unnecessary mistakes.

So far, we have seen a lot about asset classes. Now, we will start talking about ways to actually build your portfolio by choosing the right security selection strategy and discerning from good and bad security selection practices.  

Three Security Selection Strategies

This step in the portfolio creation process is very personal and it depends on what your goals and characteristics are as an investor.

We believe there are three main paths when it comes to security selection depending on your risk tolerance, involvement level and the overall strategy you prefer:

Investing in Companies

This strategy consists of buying securities from publically traded companies that you believe will provide positive returns to your portfolio. This is considered the essence of investing and it tends to be the most rewarding strategy. However, it is also the riskiest and most involved path.

Investing in companies can be done by purchasing their stock or their bonds (later on we will discover how to actually do that and we will learn everything about securities). 

However, before investing in any company, it is crucial that you perform the proper research and analysis of their financial health and their underlying potential and value (we will examine this deeply and comprehensively in future segments and courses). This is an amazing and very important task that takes some dedication and knowledge, but it can make a difference in the long-run.

On top of that, it is paramount to stay on top of your picks (companies you choose to invest in) and to have a flowing allocation. Even though you should invest in companies for the long-term, it is ok to make mistakes, so sometimes it is necessary to make adjustments and clean up your portfolio. 

  • High reward: adding the right companies to your portfolio can increase your returns significantly.
  • High risk: finding the right companies is difficult and it’s easier to lose money.
  • High involvement and research: you will have to actively manage your portfolio and do extensive research before investing (somewhat time-consuming)
  • A lot of experience: as with everything, experience will make you better. Trying and failing will help you improve and get better results.
  • High level of capital: it normally requires more money to invest in multiple companies.
  • Difficult to diversify: it is hard to get properly diversified, as a lot of money may be needed since you are investing in individual companies. However, that may help investors get the right exposure to exactly what you want. 

For example, investing in Apple (with the ticker, AAPL) in 2010 would have yielded amazing returns. However, that return comes at a really high risk.

If you want to learn how to do that, check out our amazing courses.

Investing in Funds

This strategy consists of buying a variety of investment funds that fit the allocation you want based on your characteristics and risk tolerance. 

We have seen what investment funds are in previous sections. As a recap, a fund pools the capital from many investors and invests it across a wide range of asset classes, sectors, geographical locations and more.

Investing in funds can be done by buying into Mutual Funds or by buying Exchange Traded Funds (ETFs). We will get into a lot of detail in future sections, but for now, know that mutual funds tend to require higher minimum investments, they may also have higher costs as they are actively managed and may be less liquid. ETFs are similar to mutual funds but they are traded basically like stocks, which gives them high liquidity. They are normally cheaper and passively managed.

As you can imagine, this strategy has many advantages. It is extremely cheap and simple. There are many funds out there and not all of them offer the same perks and advantages. Therefore, it is important to do some research about the funds before investing in them (we will examine how to identify good funds in future sections).

  • Low-medium reward: owning funds may help you receive steadier returns but they tend to be slightly lower.
  • Low-medium risk: having the right mix of funds can help you control your risks and reduce them significantly.
  • Low involvement and research: you don’t really need to stay on top of your portfolio all the time, as they help you create a solid passive strategy. As we will see, you may want to revisit them every once in a while for rebalancing. Also, they require some level of research but not as much as with companies.
  • Little experience: having experience would help, but it is not really required to have a successful fund portfolio.
  • Low level of capital: it is really cheap and easy to get exposure to a lot of companies.
  • Easy to diversify: it is the ultimate way to help you get properly diversified, as funds allow you to get exposure to hundreds or thousands of companies or securities in one small investment.

For example, investing in the S&P 500 ETF (with the ticker, SPY) offers a great deal of diversification across 500 of the best and biggest companies in the US. So, it provides high returns and helps you control risks. However, a higher degree of diversification may be needed if you want exposure to smaller companies or to other asset classes, for instance.

If you want to learn how to do that, check out our amazing courses.

Investing in Companies & Funds

This strategy is a combination of the other two, and it is our recommended one. It consists of buying a combination of stocks and funds and holding them in your portfolio. This is particularly interesting because it allows investors to get all the perks from investing in funds while also focusing some amount of capital to companies they believe in.

  • Medium reward: owning funds alone may not be as rewarding as good individual securities, but introducing both funds and securities that you know about can increase your return prospects. 
  • Medium risk: having the right mix of funds and securities can help you control your risks but it may be riskier than just holding funds.
  • Medium involvement and research: some level of involvement is needed to keep track of your securities and to rebalance your portfolio. 
  • Some experience: you don’t need much experience to invest in the funds’ section, but it is recommended to get some experience in trading securities.
  • Low level of capital: it is really cheap and easy to get exposure to a lot of companies.
  • Easy to diversify: it is the ultimate way to help you get properly diversified, as funds allow you to get exposure to hundreds or thousands of companies or securities in one small investment.

Stocks for what you know, funds for what you don’t

Here is a simple but powerful idea:

  1. Invest in ETFs or mutual funds to get diversified in asset classes and/or sectors you don’t particularly know much about or aren’t interested in.
  2. Choose one or two sectors or asset classes that you know or are passionate about and invest in securities from companies in those specific sectors or areas that you believe will provide great risk-adjusted returns.
    • Research
    • Understand how they work
    • Trade securities smartly

If you want to learn how to do that, check out our amazing courses.

Treat it as a business

Treat your investments like you’d treat a business and you will do well over time. 

It is important to understand that investing is not a game. When you buy stock in a company, you are essentially buying a piece of the company, so treat it like what it is: a business.

Most people that start their own businesses are very aware of all the risks that come with it; however, when it comes to investing, people tend to focus on the returns and disregard the risks.

  • Make it simple
  • Invest in what you know
  • Think long-term
  • Don’t get caught up in the day-to-day details 

We will discover how to analyze companies in-depth in future segments.

Get your personalized investment strategy here→

In the next section, we will learn about portfolio optimization and how important it is.

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