Topic: How To Invest

By Diversifying, Investors Help Minimize Their Risk and Boost Their Returns

Whether it is by sector, region, risk type or strategy, diversification helps investors minimize risk and power long-term gains

Your portfolio-building strategy should begin with a fundamental piece of advice that we underline frequently. Spread your money out across most if not all of the 5 main economic sectors (Finance, Utilities, Manufacturing, Resources, and the Consumer sector).

By diversifying, investors help minimize the risk of portfolio imbalance. This has two benefits. It keeps you from investing too heavily in any industry or sector that is headed into a period of big losses. In addition, by spreading your investments out more widely, you improve your chances of latching onto a market superstar—a stock that will wind up producing two or five or 10 times more profit than average. Over the course of any investing career, you need a few super stocks in your portfolio to offset the losses you’ll have from the inevitable duds.

Good portfolio management also means balancing your investments geographically.

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Build a balanced portfolio using our five sectors approach

Here are some tips on diversifying your stock portfolio:

  • When it comes to a diversified stock portfolio, stocks in the Resources and Manufacturing & Industry sectors generally expose you to above-average share price volatility.
  • Stocks in the Utilities and Canadian Finance sectors entail below-average volatility.
  • Consumer stocks fall in the middle, between volatile Resources and Manufacturing companies, and the more-stable Canadian Finance and Utilities companies. 

By diversifying, investors help minimize too much exposure to one geographic area 

One of the worst things you can do is invest so that your portfolio would suffer greatly due to a localized downturn in any one city, state or province. Ideally, your portfolio should give you exposure to much of the North American economy, plus substantial international exposure, if only through North American multinationals.

By diversifying, investors help minimize too much exposure to one investment approach

Balance aggressive and conservative investments in your Successful Investor portfolio, in line with your investment objectives and risk tolerance. Above all, avoid the urge to become more aggressive as prices rise and more conservative as prices fall.

We believe you should develop a clear idea of how much risk you are willing to accept, through good times and bad. For example, some investors become more aggressive as the market rises and more conservative as the market falls. The problem here is that all market trends, up or down, eventually reach a turning point. If you take on more risk as the market rises, you’ll wind up owning your riskiest portfolio just when the market is near a peak. That’s when risky stocks can do their greatest harm to your net worth.

Furthermore, building a balanced Successful Investor portfolio should include a mix of growth and value stocks, big and small stocks, and so on.

By diversifying, investors help minimize portfolio risk, and that is a big part of any good investing strategy

When it comes to building an investment strategy, don’t let sound bites and vague predictions warp your stock-trading decisions. Instead, minimize your portfolio risk by following our three-part Successful Investor approach: Invest mainly in well-established, dividend-paying companies; spread your money across most, if not all, of the five main economic sectors; and avoid stocks in the broker/media limelight.

Bonus tip: “Averaging in” is a sound strategy, especially early in your investment career

“Averaging in” is the practice of adding a fixed or rising sum of money to your portfolio every year, regardless of your view of the stock-market outlook.

When you make a habit of averaging in over a period of years if not decades, you are betting that the stock market will continue to rise over a lengthy period. That’s the smart way to bet, because the market generally does go up over long periods.

You should only change your yearly investment because of a change in funds you have available. In contrast, many investors only add funds to their stock portfolio at times when they think the market is going to go up. All too often, they guess wrong. They add to their portfolios and the market goes down instead of up.

If you regularly average in, you will at times add money to your portfolio just before a plunge in stock prices. Other times, you’ll buy more stocks just prior to a rise. Over long periods, you will automatically buy more often when the timing is good and stocks are headed for a rise. That’s because stock prices go up more often than they drop.

The beauty of averaging in is that by investing the same sum every year, you automatically buy more shares when prices are low and fewer when they’re high. The tactic works best when you start it early in your investing career and stick with it.

What missteps have you made in trying to minimize the risk in your investment portfolio?


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