Diversify into a number of good companies – No body knew precisely beforehand that Satyam Computers, which was fourth largest IT company in India, would end up in such a mess! So how many companies to invest in? Ideal number is 30 companies – 50% in 10 companies, 30% in second 10 and 20% in next 10. If you start with a small amount and add small amount gradually, it is not possible to invest in 30 companies in one go of course! In this case, invest systematically and increase the number to 30 step by step.
Diversify into large, medium and small companies – Large cap companies are safer. Small and medium companies can be multibagger but come with huge risk! How much in each? It depends on your risk appetite. Small and mid cap companies can give huge return, but it comes with huge risk. If you want to be on safer side and more cautious, you may limit your exposure to small-mid cap to 25% of total value of your portfolio or even less.
Diversify into different sectors and industries – No body knew beforehand the dot-com bubble would bust! How many industries and sector to invest in? When you invest 30 companies, make sure that all are not from same industry or few sectors! You can easily select 30 companies from 5-10 sectors! For example, 3-5 companies from Automobile – Hero Honda, M&M, Maruti, Ashok Leyland, Bajaj Auto etc. 3-5 companies from IT – NIIT Technologies, Geometric, Tech Mahindra, Infosys, Wipro etc.
Oh! So shall I buy all those companies selected from the different sectors right away? No, you have to see at what price are you going to buy? The current price may be far too high to enter. While some companies are available at bargain price, some are very expensive! So buy those which are available at a bargain right away and wait for those which are expensive to come down to a reasonable level.
So which is expensive and which is cheap? A share of Hero Honda is traded at Rs. 1,855.00 while a share of NTPC is traded at Rs. 204.00. Does it mean Hero Honda is more expensive than NTPC? Not really! Wondering why? It looks too complicated for you? It is not a complex theory, it is just common sense. Would you compare the face value of a 1kg packet of rice of one brand with that of 2kg of a different brand? No, you would take the equal weight to compare. What about the face value of 1kg of rice with 1kg of salt? Is it comparable? The same principle applies here.
It is not the share price alone than determines the fair value. How many shares are outstanding for the company? How much is company worth on various parameters and how much is it valued by market? And decide whether buying at current price is really worth?
Building a good portfolio of shares is a gradual process! You need a lot of patience to build wealth through investing in shares!