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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The Joy of Receiving Dividends

Dividend income is very useful. It can be used to pay for food, your hobby, your kids’ education or hobby, a wonderful vacation, a new car, rent or mortgage payments. 

Common stock dividends aren’t made equal. Dividends paid from cyclical stocks like oil and gas producers or gold/copper miners are volatile. When the underlying commodity prices rise, they will increase their dividends. Similarly, when the underlying commodities drop in price, they will likely cut their dividends.

There are some energy or gold stocks, such as Enbridge (TSX:ENB)(NYSE:ENB) and Franco-Nevada (TSX:FNV)(NYSE:FNV), which provide more trustworthy dividends. 

Personally, regardless of the dividend yield, I would only determine an investment acceptable if it provides satisfactory expected returns for the risk I’m taking. Oftentimes, it boils down to buying stocks at a margin of safety.

All that being said, I love receiving dividends.

The joy of receiving dividends

One of my most enjoyable activities is receiving dividends. Thankfully, I don’t need to manually calculate how much I receive from dividends. My bank keeps track of that. I simply download the data and use the SUM() function in my spreadsheet program to, well, sum up the dividends I receive every month. 

Come to think of it, September is one of my favourite months for dividend collection. In fact, so are March, June, and December. In these months, I receive the biggest amount of dividends!

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Wealth Creation: How to Double Your Money Faster

The beginnings of wealth creation all start from savings. Someone can become wealthy from starting their business or investing in stocks. Both require planning, hard work, and savings — particularly in the initial stage.

Some businesses can jumpstart with a loan based on a solid, viable business plan. You don’t need as much money investing in stocks. Moreover, dividend stocks allow you to start earning a return right away. Initially, regular monthly savings will carry much of the weight of growing your wealth. 

How long does it take to double your money?

Doubling your money only from saving is slow. Let’s say you’re able to save $500 a month. You’ll double your money in a month. But to double it again, it’ll take two months.

Double your money faster by earning interests. Let’s say you’re super conservative and decide to park a savings of $5,000 in a GIC/CD for five years. That’ll earn you an interest rate of about 2.2%. 

According to the rule of 72 (calculated by 72 / rate of return), it’ll take more than 32 years to double your money to $10,000 if you keep earning a 2.2% interest rate on your savings. This is better than just saving your money, but only a little better. It’ll probably maintain your purchasing power in the long run from keeping up with the long-term rate of inflation.

Double your money fastest in stocks. Stock investing is one of the fastest ways to grow one’s wealth. According to the long-term average market return of 7%, you can double your money in a little over 10 years, approximated by 72/7% = 10.3 years. 

You could do even better by selectively buying quality stocks at attractive valuations. Conservative stock investors who know their stuff should be able to get long-term returns of 10% or higher, which would imply doubling one’s money in about 7 years, approximated by 72/10% = 7.2 years.

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