Originally posted September 25, 2018. Last updated: March 27, 2021.
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Long-term investing isn’t gambling.
When a new industry, sector, or company comes into the media limelight, it can be hard to resist the urge to jump in with both feet. The feeling of FOMO (Fear Of Missing Out) can be incredibly powerful and you might be tempted to dump a lot of your money into a new opportunity.
If you don’t practice careful risk and portfolio management, you may end up wiping out a significant portion of your gains or, worse, actually damage your investment capital.
This is where using portfolio management techniques can be instrumental in handling your risk while also not making you feel like you’re missing out on a good thing.
Diversify your Portfolio
Building a quality portfolio is actually quite simple – it just takes a little thought into how you want to diversify your portfolio. Diversification is the process of picking stocks of companies from different sectors with no more than one representing a sector – no overlap.
The benefit of diversification is that your portfolio is equally exposed to five different sectors meaning that no matter what’s going on in the market, as time passes, some sectors will rally while others falter. With diversification, you may limit some upside by being underweight in a popular sector, however you also limit downside by not being overweight in a downtrodden sector.
Here are the basic steps to create a diversified portfolio with five stocks:
- Research companies you like in different sectors such as industrial, technology, pharmaceutical, consumer products, retail, energy, etc. If you need help getting started, check out Yahoo Finance – one of our favorite free research tools.
- Research and pick one company to invest in from five different sectors. Ideally, you will want to pick sectors and companies you’re actually interested in. This way, it will make the process of staying up-to-date interesting to you rather than boring.
- Allocate the same percentage of funds from your account into each of the different companies. Establish a buying strategy for each stock such as researching different price levels or buying at certain percentage decrements from the current stock price.
- Rebalance your portfolio. Rebalancing is reviewing your portfolio and making sure you still have the same core percentage you set in step 3 in each of your companies. Research has shown that you don’t have to rebalance often for it to be effective, however professional advisers recommend at least rebalancing once a year. If one of your stocks has gained and is a more significant part of your portfolio, sell some of your profits and redistribute those profits to make all of your positions even.
Why only five stocks?
You should plan to spend about a 1-2 hours each week staying up-to-date on your companies. Unless you want to dedicate a huge amount of free time to managing your portfolio, the more stocks you own, the more time you’ll have to spend.
What about speculation?
Professionals like Jim Cramer from CNBC’s Mad Money say that speculation can bring enthusiasm to portfolio management. It’s true! Exposing yourself to a new sector can be both exciting and lucrative.
However, new sectors and industries also bring inherent risk as there’s no way to know if there’s something lurking in the shadows that might strike down your new investment. If you’d like to dedicate some of your portfolio to speculation, make sure you only use money you can afford to lose.
What Should I Allocate to Each Position?
How much of your overall portfolio you dedicate to your core holdings, speculative holdings, and cash changes depending on your age and personal risk appetite. Depending on whether you’re in a rebalancing period, the allocation can change during the time of year, too.
Professionals generally recommend breaking down your portfolio by the following percentages:
Core Holdings: 75-90%
Speculative Holdings: 0-10%
As an example, here’s a chart of Irk’s current self-managed portfolio breakdown:
You can see that 60% of Irk’s portfolio is invested in core holdings, 10% the portfolio is dedicated to speculative holdings (6% to cannabis, 4% to others), and 30% is in cash.
All investors must assess their own risk appetite to determine how to break up their portfolio. The key is to establish a plan for what you want in your portfolio, and check in regularly to make sure your portfolio is in line with your plan.
Why Hold Cash in a Portfolio?
Although it might feel like you should be 100% invested in the market at all times to realize the biggest gains, keeping some cash on the sidelines will allow you to take advantage of market sell-offs or other situations that might cause some of your stocks to go “on sale.”
Also, if you’re not trading in a retirement account, you may want to withdraw your cash in case you have a personal emergency or unexpected life event that requires you to get some liquidity from the account.
How to Open a Brokerage Account
If you don’t already have an investment account, there are a wide variety of brokerage houses out there offering different fee structures and resources to invest.
Get Irked recommends Charles Schwab. There are many brokers out there, but you’ll want to make sure the one you choose is insured and offers the features you’re looking for. Charles Schwab was instrumental in lowering the industry to zero-cost commissions for trading and is constantly looking for ways to make the individual investors succeed.
Buy In Stages
No investor knows if a stock’s next move is up or down. Why buy all at once? By Buying in Stages, investors add to a position as the price heads lower, lowering their position’s overall cost-per-share.
Want to learn more about Buying in Stages?
Check out Get Irked’s feature on How to Buy in Stages by clicking here.
So, now that you know more about how to build a quality portfolio, start researching your companies, picking your stocks, and prepare to enter the exciting world of self-managed investing!