Tuesday, October 23, 2012

Core Portfolio vs. Trading Portfolio

It was the time, many years ago, when I met a friend and asked him whether he owned stocks of XYZ company, which was quite in the news those days. And his reply, somehow, stumped me. It was a reply, which I didn't completely understand that time, but once I did, it carried a lot of meaning. His simple reply was that he had it in his trading portfolio but not in his core portfolio. And I didn't know what he meant. And when I asked him, he told me.

He told me that one should always have two portfolios. One - the core portfolio, the one which one should never touch and two - the trading portfolio, which requires your constant monitoring and modifications. This is what he meant. He said the market consists of all kinds of companies, some which are fundamentally very good, some which are fundamentally very bad and the inbetweens. Some companies are always in the news, maybe for the right or perhaps the wrong reasons and such companies always attract a lot of speculative interest. Such speculative interest brings in a lot of volatility and some good opportunities to make money.

Even though the opportunity to make money may exist in the short term but it may not be a very good company to hold for a longer term. And the stocks of those companies which you do not intend to hold for long should be disposed off as soon as your trading objective is fulfilled. Some people may have a trading objective of a 1% return in a day while others may have an objective of 5% in a week and still others who have an objective of earning 10% return in 2-3 weeks. And that's exactly how long these people should retain their stock. As soon as they get their desired return they should sell out and book their profits.

Of course, like the biggest traders and investors, you too may get caught on the wrong foot sometimes. You may have bought shares of XYZ hoping to get a return of 5%. The stock did go up 2% after you bought but then fell back down. You being a wise and a "patient" investor know that it will give you a profit if you hold on to it long enough. Two years down the line, your investment is down 50% and the stock has just become a part of your "core portfolio" and probably, it's always going to remain there even if the company goes bust. Don't you think that had it been a part of your trading portfolio, you would have got rid of it when it went 3% or 4% or 5% below your buying price? You probably would have.

That is the problem with most of the people who lose money. Their portfolio consists of shares that were "once in the news" but are down in the dumps today, it consists of shares they are "stuck" with and most of them do not have any shares which should really have been invested in. At the beginning of the millennium, when dotcom companies were the flavour of the season and when Microsoft was going great guns, the great investor, Warren Buffett was asked if he had invested in Microsoft. And his reply was that he didn't invest in shares of companies having a business he doesn't understand. And since he did not understand computers, he never invested in Microsoft. That doesn't mean that he did not make money from Microsoft. He did because it was part of his trading portfolio and it was in whenever it was in the news and out whenever his trading objective was fulfilled.

Remember, to make a company a part of your core portfolio, you must understand why it must be held for long term. You must understand the reasons and the logic behind your investment and only then should you make it a part of your core portfolio. And to make it a part of your trading portfolio, you don't need to understand anything. All you have to do is to dispose it off after your desired return has been achieved. A trading portfolio needs to be looked at daily or twice a week, but a core portfolio needs to be invested into and forgotten for the next 3-5 years. Unless, of course, something drastically goes wrong with the company that you have to dispose it off otherwise.

I hope I have been able to convey to you the difference between a core portfolio and a trading portfolio. In case you still have a question, why wait? Just go below this post and leave a question in the comment box and I'll answer it right there.


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