It’s one of the things we always dream about but often never get around to doing – building our own profitable share portfolio.

The truth is that just about anyone can build their own share and achieve good returns without too much knowledge or risk.

The key to being successful is to practice good portfolio management.

So how do we do this?

What follows is a practical framework that will not only allow investors to build a profitable portfolio, but ensure they select only stocks that have a higher chance of being consistently profitable.

The list of stocks you select for your portfolio will depend on the time you have available, your resources and the goal of your portfolio.

That said, for most Australians, I’d recommend not straying too far outside the top 150 stocks on the Australian market. Why?

 Look at the following reasons:

• The stocks are highly liquid.
• They are all profitable businesses with some of the best managers in Australia.
• The stocks are bought heavily by institutions.
• They generally pay good dividend yields that have good tax credits attached.
• Reliable information about these stocks is much easier to obtain.
• The chances of any one of these companies going broke is small.
• Over a 10-year period these stocks will produce good returns.

Unfortunately, many newcomers to the share market mistakenly believe that buying these types of stocks is too expensive and that buying cheap stocks is the best method for achieving higher returns.

This belief not only costs you money, it hinders your ability to generate profits because you are investing your faith in speculative stocks.

In other words, you are speculating that a cheap stock will perform better that a solid blue-chip stock.

You want to buy quality stocks, not quantity, because this is where you will, for the most part, get the greatest returns.

The reality is when you buy cheap you are gambling with your money and taking higher risks.

If you are speculating that smaller stocks will rise faster in a shorter period of time you are taking higher risks, will result in more losses and very average returns.

It has been proven that concentrated portfolios perform better than large portfolios and provide lower levels of risk. I recommend holding no more than five to eight stocks, but depending on the goal of your portfolio you can hold up to 12. Holding more than 12 stocks will dilute your returns and increase the risks you are taking.

Simply reducing the number of stocks held in a portfolio can dramatically increase investors’ returns.

If you take this low-risk methodical approach to investing over the long term, then nine times out of ten, you will achieve far higher returns than if you try to beat the market averages by thinking you can pick the next boom stock.

Today is the last day that people can take advantage of the Governments tax incentive to place up to $1 million in super funds. In speaking to a number of people who have set up Self Managed Super Funds as a result of this offer, it is evident that they are unaware of the compliance requirements of running a SMSF. This is supported by the recent Australian Audit Office report, which found that around 25,000 SMSF had failed to lodge a tax return. While I am a strong supporter of investors controlling their assets, three issues need to be made really clear; first, there is work involved in operating a SMSF in comparison to a managed super fund; secondly, if compliance issues are not handled correctly it will potentially cost the investor a lot of money, and thirdly, the individual is the investment manager of the fund, therefore they need to have a working knowledge of the various investments available to them. If people are not prepared to take the time to understand these issues, it might be better for their superannuation to stay where it is.   
 

So what is happening on the market?

It is now 17 days since the All Ordinaries achieved its all time high of 6437.70 point on 4 June and in that time price has swung up and down within a 4% range. Last week I indicated that the current weakness in the market would continue for a number of weeks, which has certainly been the case. I also stated that there was an increased probability that the All  Ordinaries was falling into its yearly low but to confirm this we need to see the market fall below the low of 6200.10 achieved on 13 June, which I expect will happen in the next few trading days. Once this occurs I believe the market will continue to trade down to between 6000 and 5900 points before it finds support. As I have previously indicated, it is highly likely that the fall will last into mid July after which the market will trade up strongly once again.

Time is running out to take advantage of the Governments tax incentive to place up to $1 million in your super fund before 30 June. And while there are advantages to doing this, I often find that investors make investment decisions based on tax rather than the investment itself. Remember, a super fund is a simply a tax structure, not an investment vehicle and depending on your investment goals there may be disadvantages to placing all your money in a super fund. This is particularly so if your goal is to use leverage to increase capital gains as a super fund cannot borrow to invest, which could have a significant impact on someone in the wealth generating stage of life.

The other important fact to consider is that any money placed in a super fund cannot be accessed until retirement, which may not provide you with the flexibility you require to grow you net wealth. As a rule of thumb, I always say that if an investment needs a tax incentive to make it attractive, it is probably not a good investment.          

So what is happening on the market?

On of the key mantra’s I use in trading is to always wait for confirmation of a move before acting, and right now this is paying off. After trading sideways for the past month, the All Ordinaries rose strongly on Monday this week breaking above its previous all time high of 6376.90 achieved on 9 May before reversing to trade down over the past three days. False triggers such as these are not uncommon and often catch traders and investors unawares, which is why it is better, at times, to take a wait and see attitude.
  
I still believe it is too early to confirm that the market is falling into its yearly cycle low but the probability increases each day the market trades down. If the market is falling into its yearly low, we need to see it fall for at least two to fours week and more than 10% in price. With the current indecision in the market, anything is possible right now as it is still possible the All Ordinaries could rise up to trade above its recent highs, although I believe the probability of this occurring in the near future is low.

As I have stressed before, investors should take a wait and see attitude until we know for certain which direction the market is heading.

Since the Australian Taxation Office announced that Self Managed Super Funds (SMSF) could invest in Contracts for Difference (CFDs) there has been significant debate as to whether this is a sensible move. Given that investing in CFDs is considered high risk because of the leveraging involved, the opponents to this move believe that this product is not really suitable for a SMSF. Those who support this move, however, claim that investing in CFDs is just as safe as buying shares, so why shouldn’t it be allowed. Interestingly, the people opposing the move are the dealer groups and financial planners who won’t benefit from a SMSF investing in CFDs.

While CFDs are a highly leveraged instrument, the problem for the ATO has been that they support options and warrants in SMSF’s, therefore it would be difficult to argue excluding CFDs.  While I agree it is a concern, particularly if the investor does not have the knowledge or skill to trade CFDs, I believe trading CFDs is lower risk than trading options and warrants. My recommendation to anyone considering CFDs as part of their investment strategy should ensure they are educated in the reality of the risks and the knowledge to minimise their losses.

 So what is happening on the market?

If you remember, I was expecting the market to fall around 9% over 2 to 4 weeks from the all time high set on 18 April, however, as we now know it only fell 1.77% to 1 May. Based on this some of you may be thinking that is good because it signifies that the market is still bullish. While in essence this is correct, we really want to see this sort of bullishness at the start of a bull run not at the end. Let me explain.

Price travels at a certain speed in percentage terms over a period of time and since March this year price the market has travelled at twice the speed for more than twice as long as it did following the March 2003 low. This indicates one of two things: either the market is more bullish now than it was when it rose out of the last 4 year low in March 2003, or the market is in a state of euphoria like we experienced just prior to the tech wreck in 2000. In my opinion I believe it is the latter, hence my concern. Whilst I am certainly not suggesting the market will fall as heavily as it did during the tech wreck, I do believe we need to be very conscious of where the market is right now and what may occur in the future.  

So what can we expect from here? It is now likely that the market will continue to rise over the next few weeks to around 6500 points before we see a much larger fall than my original expectation possibly into June or maybe July. That said we still need to be aware that the market could still fall away at any time over the next few weeks to achieve my original price target.

It is anticipated that at the end of this financial year superannuation funds are set to deliver around a 13% return to investors, which will be the fourth year running that funds have delivered this type of return. While investors appear happy, the question to ask is are they really getting a good deal?

While funds do tend to benchmark themselves against various indices such as the S&P/ASX 200 or 300, if we just look at the All Ordinaries which comprises the top 500 stocks on the Australian market, it returned (excluding dividends) 17.79% in financial year 2004, 19.82% in 2005, and 19.01% in 2006, and so far this year it has returned 18.77%. If we include the average 4% dividend yield, then growth in each of the past 4 years has averaged over 20%. Given this, I would argue that there is a strong case for investors to set up their own self managed super funds. After all if an investor achieved only 10% capital growth and 4% income from dividends plus franking credits, it seems obvious that they would be beating the major super funds performance.    

So what is happening on the market?

Predicting what will happen in the share market on a weekly basis is a tough job because at times the market behaves erratically, which has certainly been the case over the last month.  In the past week, this erratic behaviour has really only seen the market trade sideways, with the peak on 18 April yet to be broken, which suggests we may have seen the short term peak I have been expecting.

In previous reports I indicated there was a high probability that the market would peak sometime up to and including April 18 and it is now 5 trading days since then and the market is finally falling away, which I expect will continue for at least another 1 to 3 weeks. Whether this peak is the actually yearly high I have been predicting is yet to be confirmed. If it is, then I expect the market will fall to around 5800 points. As I have indicated previously, I don’t believe medium to long term investors need to be worried about the current fall as I expect the market will return to being bullish in the not too distant future.