Risk Part 1 – Stock Diversity

19 Sep 2013 21:08
Tags diversification diversity risk

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(This post is the first of a 2 part blog to identify potential risks in your portfolio.)

As a DGI investor it is easy to get caught up in the wrong numbers. In a constant pursuit to find the best combination of dividend yield and growth it is not hard falling into the trap of continually buying the same stock or set of stocks in the same sector placing a large percentage of your investment into one basket.

Exposing most of your portfolio to a single stock, sector or industry is one of the most risky items you can financially take on. All of the modern stock market crashes had specific sectors or industries at their core.

  • 1987 – Banking Industry
  • 2001 – Technology Sector
  • 2008 – Financial Sector

If your portfolio was heavily weighted during any of the crashes your portfolio would have been in ruins. Of course some would argue that the overall markets dropped like a rock in each of these incidents but it was worse for these specific stocks as you not only lost equity value but also income as they slashed or eliminated dividend payments during that time.

Need another example? You do not need a stock market crash to be exposed to loss. In 2012 the S&P 500 gained 13.4%, a good year by any means. But, there was one sector that was suffering…basic materials. As China went through its massive growth cycle basic material stocks were booming, especially those involved with coal, iron, steel, and other base metals. These stocks were sporting high yields & fantastic dividend & earnings growth rates. Once China growth had slowed the basic materials sector was hit hard in late 2012 and most of 2013. Companies such as Cliff’s Natural Resources dropped their dividend 76% and all the while their stock price dropped like a rock.

As a DGI investor you need to be diligent in balancing of your portfolio weighting in relation to individual stocks, industries, or sectors. I have yet to figure out if there is a magic weighting but for now I have the following plan but as my portfolio grows in size I’m sure these numbers will decrease:

  1. No more than 15% of my portfolio weighted to an individual sector
  2. No more than 10% of my portfolio to one industry
  3. No more than 7% of my portfolio to one stock

Of course if you are a new investor just starting out this is most likely not feasible but you should have a plan that with each investment you build the diversification. That is why in my watch list I always use a target weighting to determine how much I want to spend and to place me on track for a diversified portfolio.

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