The first steps to diversifying your stock portfolio shouldn’t cause you to trip and fall on your face, even as a new investor. Today, we’re going to jump right into some simple steps investors can take to manage risk by diversifying their portfolio without becoming so spread out into various assets that they dilute their opportunities to make make money trading stocks. If you haven’t taken the time to read these linked articles, or the previous two in this series (Diversification Strategy & How to Diversify Your Stock Portfolio), I highly recommend it before reading more! If you have already, well, let’s go!
Steps to Diversify your Portfolio
Here’s some of the critical points (and some conclusions we can draw) from the previous articles on diversification that should guide your steps as you develop a diversified portfolio:
No One’s Perfect – Therefore, we need a diversification strategy that works when we are wrong. So, one of the ways I address this issue is by incorporating an “inverse” fund… that is, an Exchange Traded Fund (or similar product) that moves in the opposite direction of the market. So, if I’m going to invest in a variety of stocks, I’ll also place an order for an inverse position such as PSQ (Nasdaq bear), DOG (Dow Jones bear), or SH (S&P bear). There are several options available to the investor, but these three are simple choices that are easy to understand. For Canadian investors, you might want to consider HXD.TO (TSX bear), HSD.TO (S&P bear) or other Horizon beta products. Not everything will go up… so without complicating matters with options or short selling, these inverse funds are a great way to diversify your portfolio so you can make money when the markets are in decline.
Diversify, NOT Dilute Your Portfolio – Having too many stocks can be too much of a good thing. Sure, you many minimize the impact of declines in one particular stock, but you’ll also lesson the impact of gains in another. Instead, consider letting go of bad trades to minimize your losses in positions and simply have fewer positions. A general rule of thumb would be no more than one stock for every $2500… but preferably, $5000. As your portfolio grows, the number of stocks you own should be capped at a manageable number (more on this to come). When you no longer have time on the weekend to review the latest news on your stock holdings and announcements from the companies, you hold too many stocks.
Develop a Global Diversification Strategy – Start with what you know… and what you use… but be careful when put all your money into one or two sectors and in only one part of the world. Consider diversifying your holdings to reflect more than one type of sector or more than one country.
A Diversified Portfolio Model
As you spread your money across various assets, consider the following investments:
Gold – While I’m not a gold bug, this asset is unique. It is the one global currency with limited supply (you can’t simply print more). While you can own the physical gold itself, a more reasonable approach might be to invest in a gold company. However, less risky yet is the Exchange Traded Fund trading under the symbol GLD that fairly accurately reflects the movement in the price of gold on a day to day basis.
Real Estate Investment Trusts – REITs provide investors with the opportunity to diversify through owning land and buildings, both retail and commercial, without the large capital expenditure. Often accompanied by healthy dividends and the opportunity for capital appreciation, REITs are a smarter and safer way to invest.
Dividend Paying Stocks – When stocks are able to pay and raise dividends, they signal an increasing strength of the underlying business. So look for stocks with consecutive dividend increases and reasonable yields (beware of the 10%+ ones – they may not sustain them). I recently did an article on Enbridge, a company with strong fundamentals and increasing dividend payments.
Growth Stocks – Watch for stocks that are growing their revenues, not merely cutting expenses. If the sales numbers are increasing and they are able to generate increasing revenue with minimal expenditures, common sense says you’re likely to make money. So pay attention more to the future expectations announced in the media than whether or not they met previous targets.
Foreign – Consider owning a stock that is based in another country. For those in the US and Canada, this is a simple exercise since there are so many great companies either north or south of the 49th parallel. Don’t ignore them… but look for them. Many stocks, such as Enbridge or Lululemon, trade on both the US and CND exchanges. So do a little cross boarder shopping in two of the healthiest economies in the world.
Speculative – I hesitate to mention this one because the inclination of many investors is to be gamblers. I’m not talking about penny stocks or sub-$5 stocks. I’m talking about those lesser known names that have some revenue in place and a proven product, but may not be the leaders to their respective sectors yet. A recent name in my portfolio that matches this criteria is HEK, a lesser known oil services company.
In a couple of days, we’ll take a look at what a diversified portfolio might look like using some real figures and real stock examples. We’ll examine the small portfolio of $5000 and the larger one of $50,000 to give you some ideas. I realize many of you are newbies… and nervous about investing in the markets. A diversification strategy can go a long ways toward a good night sleep when investing. Simple principles such as “the less you have, the less risky the stocks you should invest in” can help you find success early on and build your wealth capital.
So join me in a couple of days when we’ll take the next steps. In the meantime, be sure to let me know if you’re comfortable with the pace as we take the first steps to diversifying your stock portfolio.