My Stock Investments: Stock Picking With Diversification

I recently discussed my investing strategy which involved putting together an investment portfolio that is suited for the part time investor. I’ve mentioned before that what works for you may not necessarily work for others but in the end what counts is that you actually make money using your approach. In the world of investing, how much profit you make is what matters (just as long as the means to your success is legitimate).

Image from ehow.com

I want to expound on my thoughts on stock market diversification: Here’s how I would diversify my portfolio: in a nutshell, I’d put my money into different “buckets” or “islands” (these are just basically different stock sectors or asset classes depending on how you decide to diversify). Let’s say I take $10,000 and break it up into five islands. Each island (or diversification bucket) has to be different from the others. We should all diversify because it’s essential to managing our investment risk.

My Stock Investments: Stock Picking With Diversification

So let’s take a look at how I would utilize $10,000 to purchase stocks representing various sectors. How should we divvy up the $10,000 across the different investment “islands”? Following is the basic idea behind my individual stock portfolio, which I’ve built with a good amount of thought, care and research. The following illustration shows how $10,000 is divided into five $2,000 portions:

Island 1 — The Financial Stocks: With only $2,000 to use, you’ll only have enough funds to purchase one stock in this sector. Some examples to consider are JP Morgan Chase, Bank of America or Goldman Sachs (remember to review each stock’s underlying value).

Island 2 — The Tech Stocks: Check out Apple, Google, Hewlett Packard.

Island 3 — The Health Care Stocks: Look at Abbott Labs, Johnson and Johnson, Gilead.

Island 4 — The Energy Stocks: Some examples are Chevron, BP.

Island 5 — The Higher Risk Stocks: It may be a good idea to incorporate the stock of a small, up and coming company in your portfolio.

Note that this is just a hypothetical set up. To be honest, this example is quite simplistic because the true benefits of diversification are best met through investments that are as uncorrelated as possible. So while it’s a good idea to diversify among stock sectors, you can easily achieve this type of diversification by purchasing an index fund or general mutual fund. But for better diversification, you should actually buy mutual funds that represent various asset classes (e.g. a domestic stock fund vs a foreign stock fund vs a bond fund and some cash).

Tips On How To Build A Stock Portfolio

Here are more basic tips on how to develop a successful stock portfolio:

1. Listen to those who are making money.
Of course, the hardest part about building a stock portfolio is picking the right stocks. This is the subject of many books and articles, and everybody has their own way of figuring this out. You can learn by listening to those who are making money. I’ve admitted before that I follow and study Jim Cramer’s stock picks (your mileage may vary on this one).

2. Understand the difference between a stock’s price and its value.
My second word of advice for stock pickers is that they should use common sense. Think about it: you would never go to a store and buy something on the clearance rack hoping that down the road it will be just as valuable as the more expensive, popular items that are available. Yet amateurs and novices do this with stocks every day. Of course there’s a chance for stocks to appreciate, but you’ll need to make sure that you buy stocks that have value. Just don’t forget that price does not necessarily equate to value.

3. Go for quality stocks that pay a good dividend.
For a relatively conservative portfolio, look at high quality companies that pay a dividend. Earning dividends is like earning a yield on a high interest savings account. Regardless of how the stock does, you’re still getting paid to hold it. Now if you decide to hold a stock that doesn’t pay a dividend, then you should have a lot of confidence in its potential to grow.

4. Avoid day trading or timing the market in the short term.
Finally, the retail or part time investor should avoid timing the market on a short term basis. If you don’t have much time to spend assessing stocks and the markets, then you should instead think of a less active investing approach; in this case, it helps to think long term.

To get started, set up your islands and pick some of the best stocks that fit into these sets. So which stocks should you put in which groups? To work this out, you’ll need to read and learn about stock market technical analysis vs fundamental analysis, but my final word of advice to you is this: don’t be afraid to use somebody else’s advice as a way to back up what you’re thinking. But don’t follow someone blindly either — you need to know why you own a stock. So get reading and start investing!

 
Contributing Writer: Tim Parker from Elementary Finance.

• Stock trades: Free stock trades from Zecco, Cheap stock trades from TradeKing, Stock news and Investment info at INO TV Free, No cost Trend Analysis for stocks
• Earn top returns: FNBO Direct [1.90%], HSBC Direct [1.65%], WTDirect [1.76%], E*Trade Bank [0.95%], ING Direct [.25% to 1.65%]
• Cash bonus: Discover More [$50], American Express [$25], Lending Club [$25]

If you enjoyed this post, you can get free regular updates through our RSS Feed, or you can have our latest posts delivered to your email inbox by supplying your address here. Your address will only be used for this purpose, and you can unsubscribe anytime. Share This: Save to del.icio.us Digg This! Stumble It! Submit to Reddit Email This

Categorized under: Investment