Diversification for your portfolio is a concept revolving around risk management. The idea is to hold different asset classes that have little correlation to each other, so if one asset class performs badly, another class still does well, and your overall portfolio remains intact.
In the stock investing world, you’ll find that real estate investment trusts (REITs) and precious metals stocks tend to have less correlation to the market.
So, it may make sense to have a portion of your stock portfolio in the likes of Canadian Apartment Properties REIT (TSX:CAR.UN) and Wheaton Precious Metals Corp. (TSX:WPM)(NYSE:WPM) when they’re at good valuations.
Right now, based on their operating cash flow multiples, Canadian Apartment Properties looks expensive, and Wheaton Precious Metals looks reasonably priced.
Sectors and industries
To be sufficiently diversified, you should also consider companies in different sectors and industries.
For example, in the consumer discretionary sector, there are many industries, including auto components, automobiles, leisure products, and media, to name a few.
Of course, you should be selective about the sectors and industries you wish to invest in. If your goal is to build a stable dividend portfolio with below-average volatility, then you’ll probably want to avoid most of the materials and energy sectors.
For your convenience, the other sectors are industrials, consumer staples, healthcare, financials, information technology, telecommunication services, utilities, and real estate.
Size of the company
If you only hold large-cap companies, then you will be giving up the potential growth that small and mid caps offer. That said, small and mid caps are riskier than large caps. So, some investors would rather invest in mutual funds or exchange-traded funds (ETFs) for their small- to mid-cap exposure.
Do you have too much invested in Canada?
Apparently, too many Canadians are overly patriotic without realizing it. If you are only invested in Canadian stocks, you should consider diversifying internationally to, say, the U.S. and Europe.
Like always, be critical about how much you pay for a company. Generally, Europe is where value can be found today. Again, if you’re uncomfortable buying specific stocks in those countries, consider ETFs instead.
So, how many stocks do you need?
Some say that as little as 10 stocks are sufficient for diversification purposes. However, at the end of the day, you need to be comfortable and sleep well knowing what you hold in your portfolio.
For most investors who have sizeable portfolios, holding only 10 stocks is too risky. Given an equal-weighted portfolio, if even only one of the businesses does poorly, 10% of the portfolio will be in at risk.
Some investors have more than 100 stocks in their portfolios. Now, I think that’s overkill and, not to mention, it’s probably impossible to keep up to date on what’s going on in every company.
