Building a portfolio from scratch

In late 2003 and early 2004 as the market emerged from a period of malaise I began to get more serious about putting together a reasonable investment portfolio. I really wanted to get some scale and some structure rather than the fairly rag-tag random bunch of stocks and cash holdings I held. I also was – and remain – primarily interested in shares rather than bonds or property.

This is because I really have trouble paying what I think are massive entry/exit costs for investing in direct property – not to mention the ongoing maintenance or fees payable – and bonds, frankly, aren’t that exciting. That said, no doubt bonds will have their day in the sun some time in the next couple of years as I think Aussie rates will begin to fall.

Looking back, after several years of really strong market performance, it’s interesting to review the decisions and seek improvement. For anyone who does want to get serious about putting together a decent investment portfolio I hope there might be some ideas or help here. Firstly, here's how the asset allocation looks now:

I started with a sliver of my own equity – and I do mean a sliver, only a very small amount – comprising shares and a bit of cash, to which I added a margin loan. My initial LVR was 67% versus a loan limit of around 70% so there was some risk that a short term market correction could have screwed everything up.

I considered a number of risks that would be common to many other retail investors, and considered how I could manage them. My primary concerns were:

1. Not earning at least a market return (particularly with a margin loan) – this was equally a concern for buying into a managed fund as individual stocks
2. Buying at a peak and having to suffer for a couple of years
3. Lack of confidence in my stock selection methods
4. An unwillingness to pay entry fees on managed funds – it’s a total waste of money at with some of them looking to charge up to 4% expensive
5. Dealing with a margin call

I decided to deal with point 1 by putting just over 50% of the margin loan proceeds into Vanguard’s Australian share index fund with the remainder into an Australian industrial share fund, avoiding the entry fee on the latter by downloading the forms from their website. I spent a fair bit of time thinking about whether it was better to put all into the index fund or to chase some of the other ‘hot’ managed funds at the time. I decided that it was preferable to go for the index fund because of the gearing. I felt that in my situation I simply couldn’t run the risk of an underperforming fund manager in a bull market. I think this is a common fear for many investors that I’ve spoken to.

For point 2, I decided that a key part of my strategy would be to add to my investments regularly although I didn’t setup a regular savings plan with the managed funds, preferring to pick and choose where the money went each quarter. Three months gave me enough time to save a reasonable amount.

Point 3 was interesting. Of additional investments made since commencement, maybe 30% have been in managed funds – actively managed international shares – so I’ve been selecting local stocks to fill the rest. I’ll deal with how that has gone in a later entry, but suffice to say I am a lot happier with my methods now: bull markets are great for confidence.

I wasn’t that worried about margin calls but I maintained – and still do – cash readily accessible just in case. I have a worksheet linked up to the ASX and fund manager websites so I can get valuations almost real time (if necessary – it’s not) and my key risk measures are LVR and % fall to trigger a margin call. It’s easily managed.

As far as operating the portfolio I’ve tended to reinvest distributions/dividends where possible. As mentioned, maintaining a watch on LVR means I have targeted a gearing of 55-60% so when it slips under I can add to investments. If it goes over too much I just work to bring it down.

There’ve been a few hiccups on the administrative side and I have learned to follow up every written instruction to my margin lender with a phone call.

Overall I'm quite happy, the original 'sliver' of equity has increased by almost 7x on the starting point (this includes capital gain, income and savings contributed to the portfolio).

My focus now is to continue increasing my exposure to international equities, a strategy that I began in 2005/06 and have been pursuing for as long as the AUD remains strong. As mentioned above, I have the view that the differential between local and overseas rates will fall in the near term – 12 months – causing the AUD to fall as well. I’m buying internationally-orientated companies and actively-managed international share funds. Additional investment on the ASX is on a very stock specific basis right now.

Comments and questions welcome