As you think about how to build an investment portfolio, include diversification, investing in well-established companies, and other ways to cut risk

How to build an investment portfolio: Here’s Our Successful Investor approach

• Invest mainly in well-established, dividend-paying companies.
• Spread your money out across most if not all of the five main economic sectors: Manufacturing & Industry, Resources & Commodities, the Consumer sector, Finance, and Utilities.
• Downplay or avoid stocks in the broker/media limelight, where a modest business setback can set off a deep, sudden and sometimes permanent drop in the stock.

Our first rule tells you to buy high-quality stocks. Most of these stocks were already succeeding in business prior to the last recession. This suggests that they have a durable business concept. They can still wilt in economic and stock-market downturns, of course, like any stock. But most will thrive anew when the good times return, as they inevitably do.

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Ideally, some of your picks should have hidden assets. That is, assets that many investors disregard or fail to appreciate.

The classic example is real estate that is worth a lot more than its balance-sheet value (which is usually the purchase price, minus depreciation on the buildings).

Another source of hidden value is successful research and development spending. These outlays get written off against current-year income, much like day-to-day expenditures such as rent and utilities. This accounting treatment depresses current earnings. But if the research turns up anything of value, it adds to long-term profit.

The best time to find hidden assets is when they’re still hidden, long before the company begins taking steps to profit from them. Understanding and seeking out hidden assets while you’re evaluating a stock can add enormously to your profits in the course of an investing career. But you need patience to profit from them, because they can stay hidden for a long time after you buy.

Hidden assets can also cut your risk. Stocks with hidden assets are likely to hold up better than those whose assets are easier to spot, since they are the last stocks that experienced Successful Investors sell. When times are good, on the other hand, stocks with hidden assets tend to do better than average. Good times give them opportunities to put their hidden assets to work.

Our second rule tells you how to diversify effectively, rather than simply buying a variety of stocks. 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. This cuts your risk of losses. But, by spreading your investments out more widely, you also improve your chances of latching on to 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.

Our third rule keeps you out of stocks in the broker/media limelight — including investor fads, particularly when they are nearing a popularity peak. Getting in at the peak of an investor fad can be extremely costly, as recent bitcoin investors can tell you.

How to build an investment portfolio for long-term success

Follow our Successful Investor rules over long periods and you’ll probably achieve better-than-average investing results. But your results will be uneven, in a variety of ways. They’ll vary widely from year to year. In many years, most of your profits will occur in only a few of the sectors; you may lose money in the others. Some years your U.S. stocks will provide most of the profits. Some years, your biggest profits may come from groups you hardly thought of as groups, such as Nasdaq-listed stocks, or your biggest multinational companies.

Over long periods, you’ll probably find that a third of your stocks do about as well as you hoped, a third do better, and a third do worse. This is partly due to that random element in stock pricing, which we’ve often mentioned. It also grows out of the proverbial “wisdom of the crowd.” The market makes pricing mistakes and continually reverses itself. But the collective opinion of all buying and selling in the market eventually beats any single expert opinion.

How to build a Successful Investor portfolio to protect against market slumps

When the market slumps, you may zero in on your worst performers, and dwell on what you could have done to avoid them. You may calculate how much more money you would have made, if not for hanging on to your worst stocks. This may lead you to “cut your losses,” as brokers say—sell your worst performers—just to avoid the stress of concern over future losses.

One problem here is that much of the damage may have already been done.

Many investors try various ways of eliminating losing stocks from their portfolios. These efforts often backfire. Some lead you to sell stocks that had already fallen a great deal and are ripe for a rebound. Others lead you to switch into better-performing groups just when these groups may be on the verge of joining in the plunge.

How to build an investment portfolio that cuts risk—and increases profits

• Look beyond financial indicators.
• Develop a clear idea of how much risk you are willing to accept, through good times and bad.
• Think like a portfolio manager.
• Diversify geographically.
• Hold a reasonable portion of your portfolio in U.S. stocks.
• Give your investments time to pay off.

How have you structured your investment portfolio for long-term success?