A diversified stock portfolio is key to successful investing

diversified stock portfolio

A well-diversified stock portfolio should be tailored to your personal investment goals and temperament.

One of our key rules for successful investing is to maintain a diversified stock portfolio. This means to spread your money out across most, if not all, of the five main economic sectors: Manufacturing & Industry; Resources & Commodities; Consumer; Finance; and Utilities.

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 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.

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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.

Conservative or income-seeking investors may want to emphasize utilities and Canadian banks for their 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 within the sector, and for exposure to a number of areas.

Things to avoid when building a diversified stock portfolio

Always maintain a diversified stock portfolio—and avoid the temptation of a sector rotation strategy.

So-called “sector rotators” try to predict which sectors will outperform other sectors. But trying to pick winning sectors—and staying 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, and then sell before the sector stumbles. It’s virtually impossible to consistently succeed at all three over long periods.

There are many theories about which sectors will outperform at any given stage of the economic cycle. But investors who attempt to pick winning sectors often wind up with big holdings in the worst-performing sectors. That would be devastating to any diversified stock portfolio, even if you confine your investments to well-established companies.

Avoid using model portfolios because they often overlook an individual investor’s goals. There are a number of problems with recommending a model portfolio for a large number of investors. The main one is that each investor has different goals, risk tolerance and so on. For example, as mentioned above, conservative or income-seeking investors may want to emphasize utilities and banks for their high and generally secure dividends. More aggressive investors might want to add more Resources or Manufacturing stocks to their portfolios. A well-diversified stock portfolio may mean different things to different investors—and models will likely fail to capture those differences.

As well, model portfolios need to be continually monitored and updated as individual stocks rise and fall in value, and as a percentage of the total portfolio.

Different investors may be more comfortable holding a larger or smaller number of investments in their portfolios, including stocks, mutual funds or exchange-traded funds (ETFs). So you’d need to be careful in setting any specific number of investments in your holdings based on a model portfolio.

Basing a diversified stock portfolio on a model portfolio has other disadvantages

Some model portfolio services sold by unscrupulous firms have an even more blatant advantage over real world investing. These companies will base their buys and sells on a portfolio that is calculated from the previous day’s closing prices. This alone gives them the magic wand they need to claim extraordinary results without any investment analysis.

All they need to do is simply check the market just before the close every day for stocks that have risen 5% or more since the previous day. Then they “buy” the ones that went up, and “sell” any that went down, in each case at the closing price of the previous day.

That way, they can claim credit for as many risk-free 5% gains as you need, and create whatever hypothetical profits they dare to advertise.

The saying “One size fits all” does not apply to investors looking to create a uniquely diversified stock portfolio.

Do you feel that you a have a well-balanced diversified stock portfolio? What approach did you take when building it? Share your experience with us in the comments.