Category Archives: Stock Portfolio Building

Is Your Stock Portfolio Sufficiently Diversified?

Diversification simply means spreading your risk. The idea is that different sectors and industries are exposed to different risks and therefore, they will take turns outperforming or underperforming in different economic or market environments.

For example, you wouldn’t want 50% of your dividend portfolio in bank stocks because they would get hit hard in a financial crisis or recession.

Although during a recession, likely all sectors and industries will be impacted, some will recover faster than others. That’s where it’s advantageous to hold a diversified portfolio versus one that’s concentrated.

Stock portfolio building is a journey that’s not necessarily a straight or rosy path

Today, I’ll introduce a few ways to think about stock portfolio diversification. Here’s a dividend stock portfolio building example.

Diversification by sector and industry

The Global Industry Classification Standard (“GICS”) categorizes stocks across 11 sectors, 24 industry groups, 69 industries, and 158 sub-industries.

The 11 sectors are Communication Services, Consumer Staples, Consumer Discretionary, Energy, Financials, Health Care, Industrials, Information Technology, Materials, Real Estate, and Utilities.

The rule of thumb is to not own more than 25% of one’s stock portfolio in a sector. You don’t necessarily need to invest across all 11 sectors, though. For instance, many Energy, Materials, and Industrials stocks have more unpredictable earnings due to the ebbs and flows of the economic cycle. 

Therefore, it might serve investors (especially new investors) better to start investing in the other 8 sectors first. However, coming out of a recession — in an economic expansion, Industrials stocks would do very well.

Notably, Biotech stocks, in the Health Care sector, are highly unpredictable as well. Small-cap biotech stocks could be multi-baggers or make investors lose their shirts!

Some sectors have more industries to choose from. You don’t need to invest in all industries. Play with the interactive tool at the GICS website to see the various industries.

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High Inflation: Beat It With Dividend Stocks!

High inflation is already upon us. As BBC News reported, the U.S. saw consumer prices jump 4.2% in the past 12 months. Price surges for certain goods can be even more ridiculous. Second-hand car prices rose 10% in April versus March. 

A part of that had to do with the shortage (and consequential price rise) in basic materials like steel. The situation is similar for other raw materials like copper and lumber.

We can say something similar for Canada as well — higher inflation and higher raw material costs. The annual inflation rate was 3.4% in Canada.

The Federal Reserve aims for a long-term inflation rate of 2%, as does the Bank of Canada. The Federal Reserve explains very well here how a stable rate of 2% helps with keeping maximum employment and consumer price stability. It further clarifies that an extended period of low inflation is likely to lead to a period of higher inflation (triggered by monetary policy), which is what we’re seeing now in both countries. 

At the very minimum, Americans and Canadians need to ensure their savings are earning at least 2% a year from interest income. Of course, we can do better than that with dividend stocks.

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Dividend Stock Portfolio Building: How Big Should Your Stock Position Be?

You build a dividend stock portfolio one stock at a time. But how much should you buy the stock of a quality company until you stop? 

You might stop when the stock is no longer attractively priced or when you’ve bought a big enough position.

If you are relatively new to investing, you might be confused about these terms: “starter position”, “partial position”, and “full position”. I’ll explain them real soon (in the section after the next one).

Dividend Stock Portfolio Building Examples

Portfolio building is about spreading risks. You might refrain from buying more than 25% of your stock portfolio in a sector or 5% in a stock. For example, banks, insurance, and asset managers fall under the financial services sector. 

Under the 25% rule, these holdings cannot make up more than 25% of your portfolio when you make purchases. Under the 5% rule, you won’t have more than 5% in Royal Bank of Canada (TSX:RY)(NYSE:RY) or Brookfield Asset Management (TSX:BAM.A)(NYSE:BAM) when you buy their shares.

You might also limit how much you invest in a dividend stock by the yield it provides. For example, a high-yield dividend stock that pays a 10% yield could be risky. If so, you might only limit it to contribute to only 1% of your annualized income. It could be a great move to just avoid risky, high-yield stocks altogether. 

Not all high-yield stocks are risky. You’ll need to perform fundamental analysis on potential ideas to determine if they’re risky or not, given the economic condition or situation at the time. During a market crash, a nice bunch of quality dividend stocks could provide nice yields of 5-10%.

Here’s a concrete example. A new $11,000 dividend portfolio that’s focused on growth (or dividend growth) might look like this with $1,000 invested in each of the following:

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