CONTENTs pagE

Sandra Savemore starts out 2Malcolm Mitegrow makes plans 4Wilma Warywallet’s worry list 6The art and the science 8

With some assistance from three obliging investors, Sandra, Malcolm and Wilma, this very practical report will help you build a share portfolio from scratch.

Good things come to those who wait, they say; and so it is in the sharemarket. Three years ago, with the sharemarket boom nearing its vertiginous peak, we had trouble finding enough reasonably-priced quality stocks to fill a portfolio. Today, our recommended buy list offers around twenty blue chips and more than a dozen smaller stocks.

This mightn’t be the best of times but, for the value-seeking investor hoping to build a portfolio, it’s a darned sight better than it was.

The Intelligent Investor has managed two model portfolios since mid-2001. The model Income portfolio is designed for investors with an income and capital preservation focus; while the model Growth portfolio is a collection of our best ideas.

But, as many members have pointed out, the longevity of these portfolios creates a problem. You can’t simply replicate the existing model portfolios because they consist of a collection of underpriced, fairly priced, and even slightly overpriced stocks. Building a portfolio from scratch means only buying underpriced stocks—in other words, only those carrying buy recommendations (such as Buy or Long Term Buy—see our Subscription Companion for definitions).

This special report addresses that problem. Using our current buy recommendations, we’ve developed three sample portfolios, each designed for a hypothetical investor. If you’ve ever wanted to know how to build a portfolio from scratch, this report will tell you how to do it, using current active buy recommendations.

Before we begin, there are a couple of important things to consider. First, while we’ve developed three portfolios to suit three hypothetical investors, there isn’t a one-size-fits-all approach. Your portfolio needs to reflect your personal risk profile, objectives and preferences. The ones we’ve designed may not be suitable for you, so you should take from each what you need.

Second, a portfolio is a living organism. One designed today will (almost certainly) be slightly different from one designed next month. We might, for example, replace a stock downgraded to Hold. A year from now, it would probably look very different. The stocks that are underpriced—the only type you should buy—won’t be the same then as they are now.

Finally, one of the principles from Building and managing your portfolio is to ‘buy opportunistically’. While we’re assuming you have a lump sum to invest, patience is important. Superior long-term returns come from waiting for the best buying opportunities. These often occur after big price falls as a result of profit downgrades, for example.

With the preliminaries are out of the way, let’s now introduce you to our three investors.

reporT publiSheD DeceMber 2010

BEfOrE yOu BEgiN

This report builds on an earlier report titled Building and managing your portfolio. You’ll get more out of this report if you read the earlier one first. If you’re not familiar with The Intelligent Investor, we also recommend Value Investing Fundamentals and our Subscription Companion. All are available for download from the Special Reports/New Member Reports section of our website.

The intelligent investor

2

Meet the investors

May we present to you Sandra Savemore, Malcolm Mitegrow and Wilma Warywallet (older sister to Prudence). Sandra, Malcolm and Wilma have all joined The Intelligent Investor to help them find stock ideas and build their portfolios.

Sandra is 35, inexperienced in sharemarket investing, and has $50,000 to invest. She’s looking mainly for long-term growth but is conservative by nature. Malcolm is 55 and recently established a self-managed superannuation fund with $200,000. He’s reasonably familiar with shares and will ‘salary sacrifice’ spare funds into his superannuation fund before retiring in 10 years. Wilma is 70, already retired and keen to preserve capital and generate income. She’s a very experienced investor and has $500,000 to invest in stocks.

Sandra, Malcolm and Wilma are fortunate to have cash available for investment. But their lump sums are no accident; each of them is an excellent saver. They realised early that the ability to save less than they earned—and build their assets over time—was essential for creating wealth.

Sandra, Malcolm and Wilma have read Building and Managing your Portfolio recently and have thought about their risk profiles and objectives (we’ll consider these in more depth when we construct their individual portfolios).

In preparation for building their portfolios, they’ve been reading The Intelligent Investor carefully. They’ve found the monthly Director’s Cuts particularly useful because these roundups put major recommendations in context. For example, many Australian companies with overseas operations are currently out of favour because of international recessions and the high Australian dollar. The Director’s Cuts are also helping steer them away from hot sectors such as ‘rare earths’ stocks.

Whichever of our investors you most identify with, we encourage you to read all three portfolio profiles. Sandra is raring to go, so let’s consider her situation first.

Sandra is excited. She’s just starting out in the sharemarket and, at a recent barbeque, one of her neighbours boasted of making a fortune in resource stocks. But she’s also concerned; friends in Ireland are telling her the economy there is in dire straits, and what’s this ‘QE2’ thing in America anyway? It’s all very confusing. Ringing in Sandra’s ears, though, are the words of Peter Lynch: ‘If you spend more than 13 minutes analysing economic and market forecasts, you’ve wasted 10 minutes’.

Sandra has managed to save $50,000 and expects to save another $10,000 every year for investment purposes. Because she is young, Sandra has decided growth is her primary aim. But she has also decided she wants most of her companies to pay decent dividends, figuring they are probably safer.

While Sandra is looking for growth, she’s keenly aware of her inexperience. It’s taken her five years to save $50,000, and she doesn’t want to lose it. While her neighbour bragged about his good performance—to make up for deficiencies in other areas, she suspects—other friends had done their dough trading speculative stocks. At least until she has a few years of experience under her belt, Sandra decides to stick mainly to ‘blue chips’.

But she’s already discovered a problem concerning ‘capital allocation’. The Intelligent Investor generally recommends an initial portfolio limit for each blue chip stock of around 5%. Sandra calculates that this percentage would give her 20 stocks with about $2,500 in each. She feels that is too many for her portfolio, and notes from Building and managing your portfolio that 10–12 uncorrelated stocks [see Shoptalk] is sufficient to achieve the benefits of diversification.

Sandra decides she is initially willing to have up to 10% of her portfolio in each stock because she will add $10,000 in additional savings each year. While this means her portfolio volatility might be higher in the short term, the additional funds will allow for greater diversification over time.

saNdra savEMOrE’s prOfilE

agE: 35

ExpEriENCE: Inexperienced

pOrTfOliO $50,000 (sharemarket investments) sizE:

OBjECTivEs: Growth with medium portfolio volatility

OThEr: Saving $200 a week for investment purposes

Special Report | How to build a portfolio

3

Having read the reviews and the annual reports for each company, Sandra makes a shortlist of stocks using The Intelligent Investor’s buy recommendations. She’s particularly keen on companies with international exposure, because they seem very out of favour and, having read reviews like The case for oil (see issue 283) and The gold in oil stocks (see issue 306), she sees sense in owning oil companies, too.

Top of her list is Qbe insurance, which she likes because it’s a high quality international insurer whose shares have fallen more than 50% from its 2007 highs. She also wants a bank stock, and chooses Westpac because she banks with them, although she could just as easily have chosen commonwealth bank. While ANZ bank has growth ambitions in Asia, she doesn’t think much of Mike Smith; he reminds her of that big-talking neighbour.

international exposure

To boost her international exposure she selects the listed investment company Magellan Flagship Fund. While Magellan doesn’t currently pay dividends, she likes its concentrated exposure to high quality US companies. She seriously considered Templeton Global as an alternative, but decided she preferred Magellan’s underlying portfolio. Sandra also decides to buy Westfield Group now that it has demerged Westfield retail Trust; she prefers the former’s higher growth prospects and international exposure.

For some domestic exposure, Sandra chooses food wholesaler Metcash. Its chief executive Andrew Reitzer sounded very sensible in his Boss Talk management interview and the company’s yield is attractive, although she did consider Woolworths as an alternative. Airport operator MAp Group also has a decent yield and she likes what management has done to improve its major investment, Sydney Airport. Ten years ago, the airport was overrun with stores selling chocolate macadamia nuts; on her last trip she was so engrossed in clothes shopping she almost missed her flight.

Sandra also selects harvey Norman and brickworks. Both are domestically focused and she likes the stability that their property holdings provide. She also enjoys the occasional flutter on the pokies, so she adds Aristocrat leisure to the shortlist. Sandra notes that The Intelligent Investor is calling the company a potential turnaround, though, which sounds a bit risky. Aristocrat has a few problems so she decides to stick strictly to the suggested 5% maximum weighting.

Finally, Sandra selects the blue chip Santos and the speculative AWe for exposure to oil stocks. As with Aristocrat, AWE is risky, so she limits the stock to 5% (slightly more than The Intelligent Investor’s recommended maximum). After playing around with the various portfolio limits in a spreadsheet, she comes up with a proposed portfolio she is happy with (see Table 1)

TaBlE 1: saNdra’s pOrTfOliO

% aMOuNT div. yiEld dps sharE priCE

($) ($) (%) ($) ($)

Cash 10 5,000 250.00 5.0% 0.05 1

BluE Chips

arisTOCraT (all) 5 2,500 33.14 1.3% 0.035 2.64

BriCkwOrks (Bkw) 8 4,000 146.25 3.7% 0.40 10.94

harvEy NOrMaN (hvN) 8 4,000 185.43 4.6% 0.14 3.02

MagEllaN flagship (Mff) 10 5,000 – 0.0% 0 0.68

Map grOup (Map) 9 4,500 274.92 6.1% 0.19 3.11

METCash (MTs) 9 4,500 279.90 6.2% 0.26 4.18

QBE iNsuraNCE (QBE) 10 5,000 369.52 7.4% 1.28 17.32

saNTOs (sTO) 8 4,000 132.81 3.3% 0.42 12.65

wEsTfiEld grOup (wdC) 9 4,500 226.88 5.0% 0.484 9.60*

wEsTpaC (wBC) 9 4,500 285.10 6.3% 1.39 21.94

85

NON–BluE Chips

awE (awE) 5 2,500 – 0.0% 0 1.83

5

TOTal 100 50,000 2,183.94 4.4% Average

whaT aBOuT payiNg Off yOur MOrTgagE?

shOpTalk

uncorrelated stocks:

The intelligent investor

4

Sandra keeps 10% of her portfolio, or $5,000, in cash. She’ll be accumulating savings but holding some cash gives her the ability to take advantage of future buying opportunities and capital raisings, should they arise. She allocates a maximum of 10% to Magellan, which she’s comfortable with because listed investment companies are naturally diversified. QBE Insurance is also allocated 10% because it’s a strong idea. Apart from the riskier Aristocrat and AWE, she allocates 8–9% to the other stocks on the list. The stocks she prefers get the higher weighting; the others get 8%.

Sandra thinks about her stocks a little more, observing that Westpac and QBE Insurance together comprise 19% of the portfolio. This is within the 15–25% limit The Intelligent Investor has advised for financial stocks (see Portfolio point in Westpac boldly boosts dividend in issue 308). Oil stocks Santos and AWE together comprise 13%, which seems high but she’s prepared to accept the risk for the potential growth.

Sandra notes her proposed portfolio has little exposure to discretionary retail stocks. She knows her friends in Ireland have simply stopped shopping, and she’s worried the same might happen here. This is why she has selected Harvey Norman, where more than half of the company’s value comes from its property holdings (and its problems in Ireland aren’t exactly news).

Finally, she observes that her portfolio will have no resources exposure (apart from oil and gas). But The Intelligent Investor is cautious about larger resource stocks at the moment and she doesn’t want any speculative ones. She has her eye on bhp billiton down the track but only if the price is right.

Sandra works out the dividends she’ll receive from each stock (from Income Investor) and plugs them into her spreadsheet. Even with Aristocrat, Magellan and AWE producing little or no income, she’s managed to achieve a portfolio yield of 4.4% by including a couple of higher-yielding stocks. Depending on their prices, she might add a few lower-yielding ones, such as cSl or News corporation, down the track.

Sandra is pleased. It’s taken a while, but her portfolio makes sense. She logs in to her online broking account and notices the prices of QBE Insurance and MAp Group are both down 2% today. That’s good news, and she places orders for $5,000 and $4,500 worth of stock respectively. She’s eager, but decides to wait until next week to buy some of the other stocks. ‘Who knows? ’, she thinks to herself, ‘I might get the others cheaply, too’.

Malcolm Mitegrow is looking forward to retirement. He had been hoping to retire at 60, but the global financial crisis put paid to that. He’s had a couple of years experience with shares and, after parting ways with his last financial adviser, his new one, Colin Cawshus, recommended he establish a self-managed superannuation fund. With the paperwork done, there’s now $200,000 in cash destined for direct shares.

He doesn’t mind his work and, with the mortgage paid off and the kids having left home, he’ll stick with it until age 65. In these, his prime earning years, it shouldn’t be a struggle to salary sacrifice $500 a week into superannuation. Saving more than $25,000 a year should add to his and his wife Patricia’s nest egg and ensure they can afford the odd Mediterranean cruise in retirement.

Colin, his new adviser, seems conservative—a desirable trait, Malcolm thinks. At their last meeting, Colin had warned him that a superannuation fund wasn’t for speculating. Malcolm had assured him he needn’t worry, but Patricia had looked nervous. She’d never been comfortable with shares and was still smarting from the Telstra 3 float.

During the meeting Colin had reassured her, showing that a portfolio approach would smooth out the bumps over the long term. Patricia soon understood that, without decent growth, their retirement might be less comfortable than she imagined. Colin also explained to her that franking credits were useful in a superannuation fund, so dividend income would come in handy. The best way to deal with Patricia’s unease, he said, was to diversify widely.

It’s exactly what Malcolm decides to do. Like Sandra Savemore, he does his research on each company on The Intelligent Investor’s recommended buy list. After reading their

MalCOlM MiTEgrOw’s prOfilE

agE: 55

ExpEriENCE: Some sharemarket experience

pOrTfOliO $200,000 (sharemarket investments)

sizE:

OBjECTivEs: Growth and income with limited portfolio volatility

OThEr: Saving $500 a week using salary sacrifice

Special Report | How to build a portfolio

5

annual reports, Malcolm compiles a shortlist of the ideas that make sense to him.Unlike Sandra, he has the luxury of a larger portfolio. Because he knows his wife

Patricia will be unnerved by large swings in the value of the portfolio, he decides to strictly observe The Intelligent Investor’s recommended limits. He allocates 10% to cash for future opportunities, but the maximum weighting to each stock will be 6%.

Malcolm likes the same stocks as Sandra but his larger portfolio allows him to add others too. Following a health scare a few years back, he wants some exposure to health stocks. He’s aware of CSL as the granddaddy of Australian healthcare companies, and he also likes Sonic healthcare. His doctor has used Sonic’s pathology laboratories in the past and Malcolm remembers him saying that Sonic was the best in the business.

Malcolm’s always had a lot of respect for Rupert Murdoch too, so News corporation makes the shortlist. While the yield is lousy, the stock looks good value and is certainly much more attractive than any Australian media stock. And, when it comes to quality, it’s hard to go past Woolworths and platinum Asset Management, Australia’s best retailer and fund manager respectively.

To boost the portfolio’s income level, Malcolm seeks some decent yield stocks. But he’s aware that the value The Intelligent Investor identified in listed income securities during the global financial crisis has all but disappeared.

infrastructure stocks

Having recently read the special report Three infrastructure stocks better than QR National, Malcolm adds these stocks to his shortlist. MAP Group, Spark infrastructure and the smaller challenger infrastructure all offer decent yields, although none provide franking credits. ‘But best to go where the value is’, he thinks to himself.

TaBlE 2: MalCOlM’s pOrTfOliO

% aMOuNT div. yiEld dps sharE priCE

($) ($) (%) ($) ($)

Cash 10 20,000 1,000.00 5.0% 0.05 1

BluE Chips

arisTOCraT (all) 5 10,000 132.58 1.3% 0.035 2.64

BriCkwOrks (Bkw) 4 8,000 292.50 3.7% 0.40 10.94

Csl (Csl) 4 8,000 176.02 2.2% 0.80 36.36

harvEy NOrMaN (hvN) 4 8,000 370.86 4.6% 0.14 3.02

MagEllaN flagship (Mff) 5 10,000 – 0.0% 0 0.68

Map grOup (Map) 5 10,000 610.93 6.1% 0.19 3.11

METCash (MTs) 5 10,000 622.01 6.2% 0.26 4.18

NEws COrp NON–vOTiNg (Nwslv) 4 8,000 76.74 1.0% 0.139 14.49

plaTiNuM assET (pTM) 5 10,000 432.22 4.3% 0.22 5.09

QBE iNsuraNCE (QBE) 6 12,000 886.84 7.4% 1.28 17.32

saNTOs (sTO) 5 10,000 332.02 3.3% 0.42 12.65

sONiC hEalThCarE (shl) 5 10,000 498.73 5.0% 0.59 11.83

spark iNfrasTruCTurE (ski) 5 10,000 827.27 8.3% 0.091 1.10

wEsTfiEld grOup (wdC) 3 6,000 302.50 5.0% 0.484 9.60*

wEsTfiEld rETail TrusT (wrT) 3 6,000 360.00 6.0% 0.165 2.75*

wEsTpaC (wBC) 4 8,000 506.84 6.3% 1.39 21.94

wOOlwOrThs (wOw) 5 10,000 426.56 4.3% 1.15 26.96

77

NON–BluE Chips

aBaCus prOpErTy (aBp) 3 6,000 452.05 7.5% 0.165 2.19

awE (awE) 3 6,000 – 0.0% 0 1.83

CEllEsTis (CsT) 2 4,000 82.64 2.1% 0.05 2.42

ChallENgEr iNfra. (Cif) 3 6,000 767.12 12.8% 0.14 1.095

sErvCOrp (srv) 2 4,000 128.21 3.2% 0.1 3.12

13

TOTal 100 200,000 9,284.64 4.6% Average

divErsifiCaTiON Or CONCENTraTiON?

I

The intelligent investor

6

Following the demerger, Malcolm decides to allocate 6% equally between the Westfield ‘twins’. He expects Westfield Group to provide more growth and Westfield Retail Trust to provide more income, so the two stocks complement each other.

With a few years of sharemarket experience under his belt, Malcolm is comfortable with smaller, higher risk companies. Patricia still gets nervous when she hears the words ‘higher risk’ but Malcolm remembers she didn’t seem too upset about the last ‘spec’ he bought that doubled in two years.

Malcolm thinks Abacus property Group looks an attractive opportunity in the junior listed property sector—and the yield isn’t bad, either. He also likes the oil and gas sector, so AWE makes it on to the shortlist. While Servcorp and cellestis both carry plenty of risk, their growth profiles look outstanding. With his shortlist complete, Malcolm plays around with some of the weightings using a spreadsheet. Table 2 is the portfolio he proposes.

It’s a long list of stocks, with 22 in total. As the portfolio grows, he realises he’ll need to be careful about buying additional stocks lest it become over-diversified. But he’s also very aware the proposed level of diversification will keep volatility to a minimum and Patricia on side. Malcolm calculates that even if the portfolio’s largest holding, QBE Insurance, fell 30%, the total value of the portfolio would decline only 2%. His total weighting to the financials sector, including Westpac, QBE and Platinum, is 15%—pretty conservative he thinks.

Overall, Malcolm is happy with the various weightings. He has allocated 4%-6% to each blue chip (counting the Westfield ‘twins’ as one stock) and a total of 13% to five smaller, higher risk stocks. Two of these—Abacus and Challenger—are essentially yield plays. And if growth stocks like Cellestis or Servcorp don’t work out, the 2% positions won’t do much damage. Malcolm thinks to himself he can always boost the position sizes later if they remain interesting.

Malcolm also calculates the portfolio’s total income and average yield. By adding a couple of income stocks—such as Spark, Abacus and Challenger—he has managed to increase the portfolio’s yield to almost 5%. As Malcolm knows that about half an investor’s total return traditionally comes from income, he’s been careful to achieve a sensible mix.

He calls Colin Cawshus and tells him the portfolio is ready for implementation. Malcolm emails the spreadsheet over, and Colin looks it over approvingly before processing the transactions.

Malcolm sinks back into his chair and thinks, ‘time for a glass of red’. As if reading his mind, Patricia, love of his life, walks in with one. ‘So when can we book that Mediterranean cruise? ’, she asks.

Wilma puts the phone down. She always enjoys speaking with little sister Prudence, who recently convinced her to re-subscribe to The Intelligent Investor. They are both experienced investors, although Wilma hasn’t spent as much time on her investments these past few years. But with her father Reg having recently passed away, she has more time and quite a bit more money.

Wilma has decided to put her inheritance—the rather princely sum of half a million dollars—into shares. Term deposits are all very well, but inflation is like a mouse, taking bites out of your cheese while you aren’t looking.

Her idea is to generate a bit more income and preserve the capital for her grandchildren. It’s so difficult for the young ones to afford a house these days, and this money will give them a leg up when they came of age.

Wilma reviews The Intelligent Investor’s current buy list and begins making a shortlist of the stocks she likes (and the stocks she doesn’t). She might be experienced but, at her age, she wants a portfolio that will let her to sleep at night. ‘Mainly big blue chips stocks with plenty of household names’, she thinks. Twenty years of investing experience has taught her that quality stocks not only tend to perform better over the long term, they help her sleep better as well.

For retail exposure she chooses Harvey Norman, Woolworths and Metcash. She shops at the first two, and likes Metcash’s stable business and high yield. She’s worried about

TaBlE 8: wilMa warywallET’s prOfilE

agE: 70

ExpEriENCE: Experienced

pOrTfOliO $500,000 (sharemarket investments) sizE:

OBjECTivEs: Capital preservation with a preference for income

Special Report | How to build a portfolio

7

too much exposure to financials however and, consistent with The Intelligent Investor’s suggested limit for conservative investors, restricts herself to two stocks. Together, Westpac and QBE Insurance will be 12% of her portfolio, less than the 15% limit.

Wilma and Prudence had discussed infrastructure stocks back in the boom and she remembered that Prudence—sensible as ever—hadn’t been keen (see Prudence says no to infrastructure, issue 195). But with stock prices and debt levels much more reasonable, they have changed for the better. Wilma knows the extra income will come in handy, so she adds MAp Group, Spark Infrastructure and Challenger Infrastructure to her shortlist.

Wilma also likes the idea of having international exposure but doesn’t want to go overboard. While she approves of Magellan Flagship’s portfolio, it doesn’t yet pay a dividend. If anything, Templeton Global Growth is more diversified and the dividends will be useful. She decides to allocate equal amounts to each listed investment company.

Wilma has always liked property, so the Westfield twins will be a major holding (she allocates a little more to Westfield Retail Trust as its yield is forecast to be higher). She also likes Abacus Property Group’s active approach to property investment and, while she usually steers clear of higher risk ideas, this one appeals to her. Servcorp is also exposed to international property markets recovering, so a 3% weighting is the maximum with which she is comfortable.

what to avoid?

With all her experience, Wilma knows that share portfolios are as much about what you leave out as what you put in. She’s read the reviews of Aristocrat Leisure but simply couldn’t tolerate the ups and downs of the business—or its share price. Besides, she isn’t too keen on poker machines anyway and, with the stock failing her ‘sleep at night’ test, she strikes it off her list. Investment bank Macquarie Group, with all those millionaires driving flash cars, is another stock she just can’t stomach. And Platinum Asset Management, while a Long Term Buy, just looks a tad pricey for her liking.

TaBlE 3: wilMa’s pOrTfOliO

% aMOuNT div. yiEld dps sharE priCE

($) ($) (%) ($) ($)

Cash 20 100,000 5,000.00 5.0% 0.05 1

BluE Chips

BriCkwOrks (Bkw) 4 20,000 731.26 3.7% 0.40 10.94

Csl (Csl) 4 20,000 440.04 2.2% 0.80 36.36

harvEy NOrMaN (hvN) 5 25,000 1,158.94 4.6% 0.14 3.02

MagEllaN flagship (Mff) 4 20,000 – 0.0% 0 0.68

Map grOup (Map) 5 25,000 1,527.33 6.1% 0.19 3.11

METCash (MTs) 5 25,000 1,555.02 6.2% 0.26 4.18

QBE iNsuraNCE (QBE) 7 35,000 2,586.61 7.4% 1.28 17.32

saNTOs (sTO) 5 25,000 830.04 3.3% 0.42 12.65

sONiC hEalThCarE (shl) 5 25,000 1,246.83 5.0% 0.59 11.83

spark iNfrasTruCTurE (ski) 5 25,000 2,068.18 8.3% 0.091 1.10

TEMplETON glOBal (Tgg) 5 25,000 949.37 3.8% 0.03 0.79

wEsTfiEld grOup (wdC) 3 15,000 756.25 5.0% 0.484 9.60*

wEsTfiEld rETail TrusT (wrT) 4 20,000 1,200.00 6.0% 0.165 2.75*

wEsTpaC (wBC) 5 25,000 1,583.87 6.3% 1.39 21.94

wOOlwOrThs (wOw) 5 25,000 1,077.18 4.3% 1.15 26.69

71

NON–BluE Chips

aBaCus prOpErTy (aBp) 3 15,000 1,130.14 7.5% 0.165 2.19

ChallENgEr iNfra. (Cif) 3 15,000 1,917.81 12.8% 0.14 1.095

sErvCOrp (srv) 3 15,000 480.77 3.2% 0.10 3.12

9

TOTal 100 500,000 26,239.64 5.2% Average

The intelligent investor

8

Unfortunately, listed income securities are also absent from her shortlist—for now anyway. She didn’t have the cash available when The Intelligent Investor identified all those underpriced income securities back in 2009. Now there is little value around. She considered the current commonwealth bank retail bond issue, but the yields on these types of securities don’t seem much higher than term deposits.

Acknowledging that income security opportunities don’t always coincide with having cash available, Wilma decides to keep 20% of her investable funds in cash. For now, the rates on internet savings accounts are pretty good. New income security issues seem to be increasing and, with all that extra supply in the pipeline, she senses that opportunities might not be too far away.

Having selected her stocks, Wilma writes out her proposed portfolio on a sheet of paper (see Table 3). With 18 stocks, she’s comfortable with the level of diversification, although her retail and property exposure is perhaps a little higher than average (particularly as Harvey Norman and Brickworks also own some property). The retailing industry might look weak at the moment, but Wilma thinks a recovery is only a matter of time. With all the money her son and daughter-in-law are spending on Christmas presents this year, she‘s astonished there was a retail downturn at all.

With every stock in her portfolio except Magellan paying a decent dividend, the average yield should be attractive. After adding up all the dividends, Wilma calculates a portfolio yield of 5.2%. It will be even higher after taking franking credits into account. In dollar terms, the portfolio will generate more than $26,000 in income annually and should provide enough growth to keep pace with inflation over the long term.

Wilma picks up the phone for the second time today. This time, though, she calls Bert at BusyTrade Brokers. ‘Hi Bert’, Wilma says, ‘I have a decent number of stocks I want to buy. Before I do, though, I’d like to discuss what sort of deal you can do me on brokerage’. Worn down after too many similar conversations with his frugal client, Bert replies, ‘Sure, Mrs W, I’ll see what I can do’.

As we’ve seen with Sandra, Malcolm and Wilma, building a portfolio is part art and part science. The stock selection is the ‘art’ bit, so don’t worry if you prefer different stocks on the buy list from our three investors.

More than anything, it’s important to remember that the price you pay is vital. The bigger the margin of safety between a stock’s price and its intrinsic value, the more likely it is to make a meaningful contribution to your portfolio’s performance.

The ‘science’ comes in the capital allocation. More capital should go to strong ideas and less to risky ones. Or, if you prefer income, more capital should go to high-yielding stocks than low-yielding ones (and vice versa). Time spent on capital allocation, and its close sister diversification, is time well spent.

While it’s never easy building a sensible portfolio, the road is less rocky than it was a few years ago. With plenty of high quality businesses on our buy list, a well-diversified portfolio is well within reach. We hope Sandra, Malcolm and Wilma have helped you achieve that goal.

iMpOrTaNT iNfOrMaTiON

The intelligent investorPO Box 1158 | Bondi Junction NSW 1355T 1800 620 414 | F (02) 9387 8674info@intelligentinvestor.com.au www.intelligentinvestor.com.au

WArNiNG This publication is general information only, which means it does not take into account your investment objectives, financial situation or needs. You should therefore consider whether a particular recommendation is appropriate for your needs before acting on it, seeking advice from a financial adviser or stockbroker if necessary. Not all investments are appropriate for all people.DiSclAiMer This publication has been prepared from a wide variety of sources, which The Intelligent Investor Publishing Pty Ltd, to the best of its knowledge and belief, considers accurate. You should make your own enquiries about the investments and we strongly suggest you seek advice before acting upon any recommendation.copYriGhT© The Intelligent Investor Publishing Pty Ltd 2010. The Intelligent Investor and associated websites and publications are published by The Intelligent Investor Publishing Pty Ltd ABN 12 108 915 233 (AFSL No. 282288). PO Box 1158 Bondi Junction NSW 1355. Ph: (02) 8305 6000 Fax: (02) 9387 8674.DiScloSure As at 7 December 2010, in-house staff of The Intelligent Investor held the following listed securities or managed investment schemes: AAU, AAZPB, ABP, ACK, AEA, AEJ, AGIG, AHC, ALL, ALZ, ANZ, ARM, ARP, AVG, AVO, AWC, AWE, AYT, BBG, BER, CAH, CBA, CCK, CFE, CHF, CIF, CLS, CMIPC, CNB, CND, COH, COS, CRC, CSL, CVW, DVN, EBT, EFG, ELDPA, FGL, FLT, FXL, GNC, GRB, HNG, HVN, IAG, IDT, IFL, IFM, IMF, IVC, KRS, LMC, LWB, MAP, MAU, MFF, MLB, MNL, MQG, MTS, NABHA, NBL, NWS, OEQ, ONT, PIH, PLA, PTM, QBE, RFL, RHG, RNY, ROC, SDG, SDI, SFC, SGN, SGT, SHL, SHV, SKI, SOF, SRH, SRV, STO, STW, TAN, TGP, TIM, TIMG, TIMHB, TRG, TWO, WBC, WDC and WHG. This is not a recommendation.DATe oF publicATioN 7 December 2010