Six Secrets To Building a Successful Investment Portfolio

Ways to Help Improve Your Portfolio Holdings

When constructing your portfolio, it is important to use these six general rules to help you successfully compound your returns year after year.
••• Adam Gault / OJO images / Getty Images

Though the list is actually much longer, as a general rule, there are six things you should seriously consider doing if you want to build a successful investment portfolio. Some of the items on the checklist may sound overly simplistic but they are vital to reiterate because too many new investors think they can ignore these rules and still do well.  It rarely works out in their favor.  Read a story about a dairy farmer who followed similar rules and retired with millions of dollars.

The specifics of how you implement each concept will differ based upon your own personal situation, so it is important that you seek the advice of a qualified tax professional and investment advisor.

1. Decide On a Clear Objective for Your Investment Portfolio

We've talked about this idea before and I've even gone so far as to explain the three reasons your investment portfolio should have clearly defined objectives. You need to know what you expect of your money. Otherwise, you are going to be like a rudderless ship at sea; no direction, no purpose. That's a terrible situation in which to find yourself, especially as you begin to draw closer to retirement.

2. Keep Investment Turnover to a Minimum

As the saying goes, don't rent stocks, buy businesses. Turnover has been shown to correlate with poor investment performance. If you aren't willing to own a business for at least five years, don't even consider buying shares unless you fully understand, and accept, that the short-term stock market is irrational, volatile, and capricious. You should want to hold things that grow more valuable over time, producing higher earnings per share and fatter dividend checks.  

3. Keep Your Costs Low

Every dollar you give up in fees, brokerage commissions, sales loads, and mutual fund expense ratio charges is a dollar that can't compound for you. What seems like a small amount of money every year can end up costing you hundreds of thousands, or even millions, of dollars in lost wealth that you can never recover.

4. Structure Your Investment Holdings in a Tax-Efficient Manner

The two greatest investment tax shelters available to the lower and middle classes in the United States are the Roth IRA and the 401(k). Both have unique rules, contribution limits, and tax benefits, but they can be incredibly lucrative if you manage them correctly. A 401(k) plan allows you to invest in a variety of mutual funds, and whatever you contribute is deducted from your taxable income. A Roth IRA works in reverse; money is taxed up front, but then there are no taxes on the capital gains, dividends or interest when you retire.

To see how this would work in the real world, imagine that you are 18 years old. You diligently put $5,500 per year into a Roth IRA and invest the money an average 8% annual returns until turning 65. When you retired, you would have just shy of $2.5 million in your account. 

5. Never Overpay for an Asset

There is no getting around it: Price is paramount to the returns you ultimately earn on your investment portfolio. I've written real-world examples of this in the past using Wal-Mart Stores as an example of how investors can become insanely overoptimistic one year, and then depressingly pessimistic the next. You cannot buy a stock with a low earnings yield and expect to do well unless it is a turnaround situation that actually turns around, or a start-up with a very high rate of growth.  

6. Don't Rely on a Single Investment, or a Handful of Investments

There is no reason you should have a lot of your money in a single stock. If you are looking for high-quality blue chip stocks that pay 3% dividend yields, why rely on a single firm?  You could easily find a dozen companies with the same characteristics, diversified across sector, industry, management team, and even country. A successful portfolio is one in which the owner is unaffected if a single company goes bankrupt or cuts its dividend. Sure, you don't like to see it, but things should just keep rolling on as the money comes in quarter after quarter, year after year.