X. Portfolio Construction

Introduction to Fundamental Stock Research

You now know the basics of fundamental stock research, so that you can make educated decisions about your investing. But before you begin buying lots of stocks, take some time to think about your personal investing goals. These goals, along with tried-and-true investing principles, will allow you to construct your portfolio in a smart and profitable way. You’ll even be able to take risks on intriguing stock picks while mitigating your risk of loss.

Here are a few things you’ll want to think about:

  • Risk tolerance. Be honest with yourself. Could you stomach lots of stock volatility in pursuit of high gains? Or would you feel faint on a bad day in the market? Your risk tolerance is largely a function of your personality, but of course it’s also about your financial situation and how much you can afford to lose.
  • Time horizon. How much time do you have to grow your investments? A shorter time horizon gives you less time to recover from losses (which are more likely to occur if you invest in volatile stocks). You can weigh your time horizon against your risk tolerance to determine how aggressive you want your portfolio to be.
  • Income vs. capital appreciation. Are you mainly looking to earn income off your investments via dividends, or are you more concerned about growing the principal? Perhaps you want a blend of both. Thinking about this mix will help you decide how important dividend yield (dividend payout divided by stock price) will be for you.
  • Amount you can invest. This may seem obvious, but the amount of capital you can invest will affect your investment choices, especially in the number of different equities you buy. If you’re only investing a small amount, you’ll want to minimize transaction fees, meaning buying more shares of fewer stocks. For example, if it costs $7 per trade, then $7 is added to your cost basis, plus another $7 when you sell. This means if you only bought one share, you would need the price of the stock to increase $14 just to break even. But if you buy 10 shares, that $14 fee gets spread over all 10 shares, meaning the break-even point is much lower ($1.40 increase in price). Those investing large amounts of capital will be less sensitive to transaction fees and should instead focus on managing risk via diversification.

This self-assessment will help you determine things like asset allocation, the types of stocks to buy, and the number of holdings.

A Really Important Rule

You have probably heard about the importance of diversification, otherwise known as not putting all your eggs in one basket (or, to use investing parlance, not allocating all your eggs to one basket). It may be a cliché, but it’s also good advice that respects the very real risks involved in investing. When you diversify, you help to protect yourself against major losses if something goes wrong with a holding.

One way to diversify is to invest in different asset classes, such as stocks, mutual funds, bonds, or exchange-traded funds (ETFs). If you can’t buy enough shares of a stock without undue fee hardship, then buying a single ETF like SPY or IVV may be the way to get diversification while minimizing transaction costs. Within stock investing, which is what we have been covering in this guide, there are also multiple ways to diversify.

The simplest way is to make sure you are investing in different stocks, and that no stock is making up too much or too little of your portfolio. The number of holdings you have will depend on how much capital you are investing, but regardless, no stock should dominate by too much (an exception to this is if you are only investing a very small amount of money, because of the fee/cost basis issue explained earlier). Likewise, there is no point in paying transaction fees on a stock that will only take up a tiny sliver of your total value and have minimal effect on total return.

To give you some ballpark guidance, in a portfolio of 5 stocks, a reasonable percentage for each stock might be 15-25% of the total value. In a portfolio of 10 stocks, a holding size of 8-15% for a particular stock should be optimal. Generally, the more cash you have to invest, the larger the number of stocks a portfolio should hold, but with that said, once you have around 30 stocks or so, the benefits of holding even more stocks for diversification purposes is probably minimal.

Another key method for diversifying is picking stocks in different industries and sectors. As a rough guideline, at Stock Rover we generally try to avoid being more than 30% invested in any single sector or 20% in any single industry.

Another more advanced way to diversify is to opt for stocks with low correlation to each other, meaning that their historical daily price movements are not too similar. Don’t worry about this one if you’re just getting started, just be aware that it is another tool that investors use. In the beginning, just be sure to select different stocks in different sectors, and don’t put too much (or too little) money in any of them.

Keep Calm and Diversify

This all takes a bit of self-discipline. If you have a stock you feel really good about, it’s tempting to buy as much as you can, diversification be damned. But, as we can never have complete information about a company or its future performance, it’s simply too risky to do that (too much single-stock risk, it’s called). Instead, use your stock research to help you create a profitable and resilient portfolio that is appropriate for your personality and financial goals.

In the next chapter, we’ll go over how to evaluate your portfolio.


These exercises will help you get started with portfolio planning. See this appendix for how to find the relevant information in Stock Rover.
1. If you already have a stock portfolio, ask yourself these questions. If you don’t already own stocks, skip to #2.

  • What stocks do you own?
  • What percentage does each represent in your personal portfolio?
  • How much dividend yield do you receive each quarter on your portfolio?
  • What industry and sector do each of your stocks belong to? What is the sector and industry allocation within your portfolio?

2. Think about and write down answers to each of the following:

  • How much do you want to invest?
  • What is your tolerance for risk?
  • What is your investing time horizon?
  • How much do you want your portfolio to provide active income, versus longer term capital appreciation?

3. Now, what does this tell you about what kind of portfolio you should construct? Can you answer any of the following:

  • On the spectrum of high growth/aggressive (on one end) to slow growth/conservative on the other end, about where do you want to be? What do you think might be a realistic portfolio growth target and why?
  • How much total dividend yield do you want to achieve? Remember that a high yield often means flatter stock price performance.
  • How much do you want to be invested in stocks, versus other asset classes?
  • About how many stocks do you want to buy?

If you’re not really sure of all of these answers yet, that is okay! Just try to pick a few diverse stocks you’re comfortable with and see what you can learn about them (and yourself) after setting up the portfolio.

Next: Performance Evaluation

This guide was created in partnership with bivio, which provides online investment club accounting and hedge fund management services.