Portfolio building is a vast science in itself. It involves the calculation of various metrics of a stock, deciding the weight of each security, each asset class, and managing them on a regular basis. Although the usual focus of a portfolio building is to diversify and have different asset classes such as bonds, fixed income securities, gold, and real estate, this newsletter focuses on equity component specifically.

In this newsletter, we will focus first on finding the type of investor an individual is. This is essential because it defines the risk to be taken by an investor. Then we will see the portfolio building process of each type of investor.

The type of investors

There are two broad types of investors based on the levels of risk aversion: Conservative investor and Aggressive investor. Risk aversion is the tendency to avoid risk.

1. Conservative investor: A conservative investor is risk averse. These investors have a low level of risk tolerance. They do not like to take on much risk. A conservative investor’s ideal portfolio will have 20 to 25 percent in equities and the remaining in bonds or other asset classes with lower risk. These investors are comfortable with a low return as long as the risk is low as well. The risk aversion comes from the lack of ability and willingness to take risk. The reason could be to avoid severe losses, lack of financial knowledge, less existing wealth, or even age. These factors are subjective.

2. Aggressive investor: Aggressive investors are completely opposite to conservative investors. These investors have the ability and the willingness to take risk. They want higher returns and are willing to take the risk as well. The ideal portfolio for these investors is one with 20 to 25 percent in bonds and other low risk assets and the rest in equities. These investors may also be completely invested in equities.

In today’s newsletter, the focus is on Aggressive investors and their investment style.

Aggressive investor and their investing style

Aggressive investors are of two types based on their style of investment: Passive and Active.

Passive-Aggressive investors are those who will not take an active part in the process of stock selection. Rather, they will invest in a pre-defined equity basket. These baskets of stocks could be mutual funds, index funds, or ETFs.

Mutual funds are pooled investment funds that are managed by a fund manager who invests the contributed funds as per the investment objective of the fund. There are various types of mutual funds, but pure equity funds exist as well.

Index Funds invest in indexes created by the National Stock Exchange or Bombay Stock Exchange. These funds closely follow the index. These funds invest in the same securities that are in the index and in the same weight as well. This is the most passive way to invest where the return of the fund matches the return of the index.

ETFs stand for Exchange Traded Funds. These are pooled investment vehicles just like Mutual funds. But unlike mutual funds, ETFs can be bought and sold on the exchanges rather than through distributors.

Active-Aggressive investors will take an active part in the decision making of the portfolio. The decisions like when to buy the stock, What stock to buy, how much quantity to buy, when to sell? All these decisions are taken by the Active investor. Active investor’s aim is to outperform the market. That is, to generate better returns than the Nifty 50. Active Aggressive investment can be done in two ways. through Value investing and Momentum investing.

1. Value investing refers to buying the stocks which are trading at a price below the intrinsic value (the true value). The intrinsic value of a stock is ascertained after extensively studying the economy, the financial statements of the company, the qualitative aspects of the company etc. The value investing approach takes a business buying perspective.

2. Momentum investing on the other hand looks only at the price of the stock. This investing style encourages the investors to ride the trend. The assumption here is that the fundamentals of the company is reflected in the price and that price is everything. The idea is to buy the stocks that are rising and to sell them when they have reached their peak. Buy high sell higher is the motto of this investing style.

Technical analysis complements Momentum investing and Fundamental analysis complements Value investing.

No matter the style of investment or trading, a portfolio approach is one where the holdings are diversified. The amount of diversification depends on the individual’s ability to take and handle the risk. The securities markets offer a wide variety of asset classes and assets to the investor; each with different risk return characteristics. The investor must understand these clearly and then try to create a portfolio that matches their risk or reward.