In this article we will be discussing how a beginner without having much knowledge in the stock market can easily select a few stocks from thousands of stocks available out there and start doing SIP in stocks easily. Every two to three months a new company is being listed on the NSE and almost around 1800 companies are there in the listings to trade and invest.
Having a popper strategy in place to select which stocks to invest before starting the SIP journey is very important. SIP in general has its own pros and cons and SIPs in stocks are a bit different. Selecting only a few good stocks to build a stock portfolio for a beginner will be highly confusing and a nightmare. Many lose confidence in seeing the wide range of stocks available to invest.
We will discuss how easily one can narrow down and select a few stocks and build a stock portfolio in good companies within minutes without breaking the head.
Selecting the Stock Universe:
First we have to select our stock universe. Stock universe is nothing but a concise list of stocks belonging to a particular category. For example, Nifty 50 – consists of top 50 companies based on its market cap. Similarly Nifty Auto universe consists of stocks related to the automobile industry and so on.
For simplicity and to reduce risk, and this article is for beginners, we are going to look into only the stocks which are market leaders and have a good market share. We are not going to invest in penny stocks or stocks that are relatively new in the market. The stock portfolio can be built from any one of the following methods:
- Index based Stock Selection
- Sector based Stock Selection
- Smallcase portfolio (either Ready made or Custom made Portfolios)
- Stocks from Mutual Fund houses
Indices based stock selection:
Selecting stocks from Nifty Indices has an in-built mechanism of selecting the market leaders and stocks that have greater valuation when compared to those that are not included in the list.
We can select any index by going to niftyindices.com. Though there are several indices in NSE, we are going to select only the Nifty 50 index as a beginner.
Nifty 50 represents the top 50 companies based on market capitalization and free float in the market. In other words, these companies are too big to fail. By selecting stocks from this index you are naturally on the winning side to make money in the long run.
Another advantage is that the stocks in Nifty 50 are reviewed by NSE every six months and the companies that fail to meet their criteria are excluded. You just have to make sure whether the stocks you have selected are in the Nifty50 index every six months once. The constituents of nifty 50 stocks can be seen in the nifty indices website. You have to download the index constituent from the site and check.
Yeah, I can hear that, ” hey there are fifty stocks to select from. Can I narrow down further?” Yes, we can. Since the inception of Nifty 50 in 1995 there has been 101 modifications that each year up to four stocks has been included and the poor performing four stocks has been excluded on an average. However, there are 12 stocks that have stood the test of time and are a part of the nifty 50 index from the inception of Nifty 50 in 1995. These are the market leaders we can focus on. We can easily start an SIP in these stocks without thinking much.
The below image represents the returns of Nifty 50 Index Vs the above said twelve market leaders. We can clearly see that these twelve stocks have beaten the index comfortably in the past 14 years (2007 – 2022 March) and have given a return of CAGR 11.77% Vs 9.56% of Nifty 50 Index.
You can also see that these twelve stocks are diversified in themselves as they are from various sectors like FMCG sector, Auto sector, Banks, Commodities, Energy, Infra. Thus, we can select only these stocks to start with and can do SIPs every month. Thereby we can create a well diversified and balanced portfolio in the long run. This can be used as an alternative to index mutual funds.
Sector based stock selection:
If you have some knowledge about macroeconomics and you feel that for some reason some sectors are going to do well in the next few years, then you can select stocks from that particular sector. For example during the Covid 19 pandemic defensive sectors like FMCG, Pharma and IT sectors performed well while the sectors like auto were badly hit.
This was because the Auto sector needed transport, manpower and imports to function efficiently. Due to lockdown there was interruption in these services. While the IT sector had the advantage of technology and the work was done from home also. Similarly, FMCG sector was less badly hit as food is a necessity.
So, if you want to invest in particular sectors like realty, pharma, auto, infra, FMCG, metals and so on, you can go to niftyindices.com and select your favorite sector and invest in the top three to four stocks of that sector.
Smallcases are modern investment products that are designed to invest in a particular group of stocks / ETfs in SIP mode. As the name suggests it is like a small suitcase where one can keep only the stocks they like to invest instead of investing in the whole index.
It’s just an app that enables the retail investors to select their own stock portfolio and start investing in it in a systematic manner. One of the problems that retail investors face when building a stock portfolio is it is difficult to distribute the money equally among the stocks in their portfolio every month. There will be weightage differences and one has to manually calculate to distribute money equally. Smallcase app helps to invest equally among the stocks without your need to do it manually. You just select the stocks and the app itself tells the amount to be invested in each stock easily either based on equi-weighted or market cap weighted.
The image below is the screenshot of my custom created portfolio based on the Realty sector. You can see that the money is equi – distributed among the stocks selected. This helps to keep the weights of each stock in our portfolio to be an approximate 10% (red arrows). This is because we have selected an equi-weighted portfolio (Orange arrow). We can also select the stocks based on market cap and also custom weighted.
If not for this app, we have to do this calculation manually every time we invest. For this they charge a very minimal one time fee of 100 while creating a portfolio. We can then execute all the transactions through our brokers like Zerodha.
However, the small case has some disadvantages also. Though they support most of the discount brokers like Zerodha, Upstox, 5 paisa, angel one, still there are brokers who are not associated with Smallcase.
Also, the amount to be invested initially will be high depending on the selected stocks. This is because all the stocks have to be given equal weightage in the portfolio which will need a good portion of money.
If you are still not confident to invest in individual stocks, you can invest in the readymade portfolios that are available in Smallcases. These portfolios are handled by SEBI registered (mostly) Fund Managers and rebalancing occurs periodically. But, most of these ready made portfolios will have a subscription fee. Remember that just because some fund manager is handling your money, you cannot expect that the returns will always be fabulous. Kindly, make your own research before investing.
Mutual Fund based Portfolios:
What if I tell you that you can invest in mutual funds without paying expense ratios? Expense ratios in actively managed mutual funds vary from 1-2% per year depending on the type of fund you invest. Larger expense ratio can hamper your overall portfolio returns in the long run.
You can avoid this expense ratio altogether and still enjoy the benefits of mutual funds just by investing in the stocks these fund houses do.
First step is to select which type of fund you want to invest in. Say, whether it is large cap, mid-cap or small cap funds. Then select a good fund house like HDFC, SBI , ICICI, Axis etc., Then select a fund from your desired category You can use historical performance of these funds by going to sites like Money Control / Value Research etc., But, don’t get too excited about the CAGR returns of these funds. Investing only based on CAGR returns may be dangerous.
Once you select the fund, look into the portfolio of the fund. Below image shows the portfolio of SBI Large and Midcap Fund Direct Plan.
Under the portfolio section (Red Arrow) you can see the top holdings of the fund. In this example you can see that this fund has invested in ICICI Bank (orange arrow) and the investment is about 5.76% (Blue Arrow) of its total investment. The second highest holding is in Page industries wit 5.26% investment and so on.
Once you start investing in these stocks, review the fund portfolio every month just to see whether there is any change in the stocks. If any stock is removed from the list without any emotion, sell that stock and buy the one which is newly included in it.
This way you can easily and freely replicate the fund house and the best part is you need not pay any expense ratio to the fund house. Fantastic right? But wait, SIP investments in individual stocks have their own advantages and disadvantages. You should be clear of what you want before investing. Unless your mind is free you cannot become financially free.
Hope you would now have gained some knowledge on how to select stocks to invest for the long term without breaking your head. These methods are not the only way to choose from, there will be “ N” ways to do it. But, investing should be approached with relaxation and your strategies should be rule based. The above said strategies has an inbuilt mechanism of selecting good companies and gives you an opportunity to remove the underperforming stocks (Nifty Index rebalances every six months- but there won’t be any changes most of the time, watch for mutual fund rebalances every month, Smallcase rebalances periodically).
At some point of time we should start investing in equities directly and the strategies mentioned above will be of great help to you if you are a beginner. Investing early is very important. Start your equity investment today. Happy Investing !!!