Investor Toolkit: Profit from our five-sector portfolio diversification strategy

Profit from our five-sector portfolio diversification strategy

Every Wednesday, we publish our “Investor Toolkit” series on TSI Network. Whether you’re a beginning or experienced investor, these weekly updates are designed to give you specific investment tips and stock market advice. Each Investor Toolkit update gives you a fundamental piece of investment advice, and shows you how you can put it into practice right away.

Today’s tip: “Diversifying your stocks across all five sectors is more than just a safeguard, it will significantly improve your chances of making money.”

One key part of our three-part investing program is to diversify — spread your money out across most, if not all, of the five main economic sectors: Manufacturing & Industry; Resources & Commodities; Consumer; Finance; and Utilities.

(The other two parts are to invest mainly in well-established, dividend-paying stocks and avoid or downplay stocks in the broker/public-relations limelight.)

Our portfolio diversification approach gives you strong potential for long-term gains

If you diversify as we advise, you improve your chances of making money over long periods, no matter what happens in the market.

For example, manufacturing stocks may suffer if raw-material prices rise, but in that case your Resources stocks will gain. Rising wages can put pressure on manufacturers, but your Consumer stocks should do better as workers spend more.

If borrowers can’t pay back their loans, your Finance stocks will suffer. But high default rates usually lead to lower interest rates, which push up the value of your Utilities stocks.

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As part of their portfolio diversification strategy, most investors should have investments in most, if not all, of these five sectors. The proper proportions for you depend on your temperament and circumstances.

For example, conservative or income-seeking investors may want to emphasize utilities and Canadian banks in their portfolio diversification, because of these stocks’ high and generally secure dividends.

More aggressive investors might want to increase their portfolio weightings in Resources or Manufacturing stocks. For example, more aggressive investors could consider holding as much as, say, 25% to 30% of their portfolios in Resources.

However, you’ll want to spread your Resource holdings out among oil and gas, metals and other Resources stocks for diversification and exposure to a number of areas.

Avoid basing your investing strategy on sector rotation

Instead of portfolio diversification approaches like ours, some investors practice “sector rotation.” That’s where you try to predict which sectors will outperform other sectors. But trying to pick winning sectors — and stay out of other sectors — seldom works over long periods. That’s because you need to guess right three times to succeed.

You have to pick the top sectors, then pick the stocks that will rise within those sectors, then sell before the sector stumbles. It’s virtually impossible to consistently succeed at all three over long periods.

COMMENTS PLEASE—Share your investment experience and opinions with fellow members

Do you hold stocks over a long period of time? If so, are you willing to hold stocks in more volatile sectors, like Manufacturing and Resources, even when those sectors are down? When you sell a stock in one sector, do you tend to look for a replacement in the same sector?

Note: This article was previously published on August 5, 2010.


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