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FINANCIAL CHRONICLE™ » FINANCIAL CHRONICLE™ » How to Diversify a Stock Portfolio

How to Diversify a Stock Portfolio

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1How to Diversify a Stock Portfolio Empty How to Diversify a Stock Portfolio Mon Jan 28, 2013 7:49 pm

notme

notme
Senior Manager - Equity Analytics
Senior Manager - Equity Analytics
When you invest in the stock market, the best protection you have against a correction is to diversify. The market tends to sell off in sectors. In other words, technology companies, like cell phone providers, likely won't move in synch with energy companies, heavy industrial manufacturers or consumer cyclical products like automobile manufacturers because each sector responds differently to movements in the overall economy. So if you place yourself in five different sectors, you are spreading your risk. The size of the companies you invest in may also provide you a way to diversify your risk. Small companies, for example, tend to rise early in economic recoveries and fall quickly during downturns, while the largest companies tend to rise more slowly during recoveries, but maintain their strength longer through economic drawbacks.

Instructions
1
Determine what kind of investor you are. Age and goals have a lot to do with this step. When you are in your 20s, you can tolerate a lot more risk to your portfolio as you have time make the money back. As you get closer to retirement, you can tolerate less risk because you will need that money sooner. Given those parameters, determine your financial goals and needs.

2
Make a list of the stocks that you think you might want to own. Homework is a huge key to investing. Don't simply act on a tip because your buddy told you about it. Chances are at that point, you have missed the run of whatever hot stock they were touting. Think about the company names that you use every day. Make a list of 15 to 20 before moving on to the next step.

3
Research the list of stocks you just made. A simple way to properly understand if a company is cheap or expensive is to look at the p/e ratio -- the ratio of the stock's price to the company's earnings per share -- and growth rate in comparison to its competitors. This sounds complicated, but it's not. Go to a financial website like TheStreet.com and type in the ticker symbol. Then find the section on the page that says "competitors." Once you bring up that screen you will see the company you are interested in purchasing and the rival companies in the same industry. Ideally you are looking for a high growth rate. (This is given in percentage on a year over year, or quarter over quarter basis.) And then a low price to earnings ratio. The p/e ratio should be below or at the growth rate.

4
Purchase stocks that are in different areas of the market. Financials, consumer products, technology, energy and transports are all different sectors in the market. There are countless others. You want to be sure to buy at least one stock in each category. Two of a kind is a bad thing. An example would be if you owned Google and Yahoo!, as they are both tech search engines -- any weakness in Internet advertising will cause the shares of both companies to tumble in unison, whereas an energy producer like Exxon/Mobil or a bank like Wells Fargo would be unaffected by that particular market factor, and might even rise on other news.

5
Buy your stocks over a period of time instead of all at once. Stocks trade in ranges and can move 5, 10, 20 percent or more on one day. To be sure that you lock in a good average price point, accumulate your position over a period of time to develop a "cost basis." For instance if a stock is $100 a share, buy half your position. If it goes to $110, that's great you've made money. But if it goes to $80, you then can commit more capital (the other half of your position) and have a "cost basis" of $90. This will limit your downside risk.

6
Most investors find it easiest to start with a portfolio of large company stocks, then branch out gradually to add small and midsized companies to the mix. The stocks of smaller companies are harder to find and to research, but solid picks in these sectors can add high octane to a portfolio's growth capacity -- along with a higher risk of losses.

7
Continue to review your portfolio. It is important that your portfolio remain in your risk class, that your companies continue to perform and that the overall market conditions stay favorable. These three items must be checked weekly. If you do not have the time to commit to such a program, you may be better off buying mutual funds and letting the pros deal with the detailed stock picking.

Tips & Warnings
To limit the volatility of your overall investment portfolio, consider adding bonds or bond funds to your mix. Bonds tend to move with much less volatility than stocks, which can provide ballast to your accounts during rough economic times.

source-http://www.ehow.com

anushka fernando


Senior Equity Analytic
Senior Equity Analytic
what is the best unit trust in sri lanka?
pls tell me your sugests...it is big help for me

3How to Diversify a Stock Portfolio Empty Re: How to Diversify a Stock Portfolio Tue Jan 29, 2013 2:28 pm

kukumarx


Manager - Equity Analytics
Manager - Equity Analytics
In Sri Lanka, one of the best paying sectors has been the banks. If I were to follow rule 4 I would have only 1 bank and would loose out quite bit!

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