Steps to Diversify a Small Stock Portfolio

The steps to diversifying a small stock portfolio, while similar to any other portfolio, has some unique challenges for the beginning investor. After all, how do you diversify a stock portfolio if you can only afford one or two stocks and all your proverbial eggs are in one basket? The tendency for many investors is to purchase a mutual fund which encompasses 100 stocks with a few favourites mixed in among a few losers. But between the dilution, the fees (such as Management Expense Ratio – MRE – and commissions), and the inability for the individual investor to actively manage this investment, too much risk is adopted unnecessarily. So let’s look at what the average investor, with $5000 or less, can do to diversify their stock portfolio.

Small Portfolio Requires Big Thinking

Why diversify anyway? If you can’t answer this question, I’d encourage you to go back and read the last section of the article Diversification Strategy. Before we ever make an investment decision, we need to be able to answer “why” we are doing so. This will help guide us and give us a standard of evaluating our decisions when we are faced with the outcomes.

Any investment of money demands diversification

Often investors think of diversification as something they need to do once they have enough funds to warrant it… often waiting for $10,000 or $25,000 or more. Let’s not wait… any investment of money demands diversification. The person with a small stock portfolio requires diversification too. It’s simply going to look a little different. Consider the following possibilities:

• Invest in an Exchange Traded Fund (ETF) – Often you’ll hear professionals encourage small investors to buy an ETF. The most popular form mentioned is the index fund. Essentially, index funds are mutual funds or ETFs that hold the same securities as a specific index (i.e. S&P, DOW, etc.). They provide a relatively low-cost way to invest in specific markets or sectors and most of them pay dividends on a quarterly or yearly basis to investors.
• Buy Gold – Sometimes, new investors are told to simply buy gold. It is a unique asset with a great track record, especially over the past 10 years. It is also viewed as a hedge against inflation and a safety net against crisis (which is not always reality).
• Buy your Favourite Stock and Hold it – There’s something to be said about investing in what you know, use, enjoy, and will be interested in outside of just making money. I’m not sure how this meets the diversification requirement… but to “buy-and-hold” a stock has some inherent flaws as the linked article demonstrates.

While there is merit to each of these approaches, there are some downfalls too. For example, when you have a small portfolio, the last thing you need is to have some fees eating your profits. Sure the fees may be minimal, but so will the profits on a small $2500 investment. That, coupled with the lack of ability to actively manage an ETF, tends to keep me away from the mutual fund and some index funds. Gold is a better option but you are hardly diversified. Nevertheless, it remains one of those unique assets with a lot of promise and potential. Here’s an alternative. Consider buying a big name stock that meets the following criteria:

• Personal Engagement – You know, use, enjoy, and follow this company’s products. It interest you and captivates your own money. It may be as boring as a food company or as exciting as a technology company. You’re engaged to this company already!
• Think Bigger – Consider a proven company with a medium to large Market Cap which simply means the total value of all the tradable shares. Simply go to Yahoo.com and search for a company. It will pull up a quote with a stock’s market cap… I’d wouldn’t consider any stock under a 10 Billion market cap and preferably, closer to 25B and up! This will keep you away from the speculative stocks that have yet to prove their longevity in the marketplace.
• Pays You – Finding a company that will pay you to hold it is worthwhile too. In fact, many companies which are making money and have a continued ability to increase revenues will pay a dividend to investors. Using the same Yahoo link, you’ll see what the company will pay you listed just below the market cap. One caution: the larger the dividend does not mean the better the company. In fact, many companies with 10% plus dividends can’t sustain such high payout rates and, eventually, cut those dividends causing the stock price to fall too. You may want to visit the article on Enbridge for an example of a great company who continues to sustain a growing dividend.

Diversified with a One Stock Portfolio

It is possible to be diversified by holding only one stock in your portfolio. Ideal? Perhaps not… but it is reality for all investors who have to start out at some point with what they have, no matter how little that may be. Remember the first steps to diversifying your portfolio, and then choose a stock you’re already engaged with, which isn’t going anywhere, and will pay you to hold onto it. Then be prepared to watch it actively… each evening for 5 minutes or less. 

I’m not a financial advisor… although I used to have that title in a major Canadian bank years ago. I’m a friend who shares personal experiences and ways I consistently make money in the markets every day no matter which way they go. I’ve learned from personal mistakes along the way and seen firsthand how hundreds, even thousands, of investors lose money due to a lack of discipline.

Remember the motto here at Invest in the Markets: Preserve Capital, Minimize Risk, and Maximize Returns. Two are defensive… which will allow for the third to be accomplished naturally. If you have specific questions, why not look me up on Skype (DoctorStock) or send me an email. Better yet, attend a free Stock Talk Webinar (such as the one on January 22nd) and take some time to discuss these real concerns in real time! We can discuss your small portfolio or, as we will do in a few days, consider options for those with $25,000 or $50,000 or more!

Successful investing shouldn’t be reserved for the “already rich.” By putting a very simple plan in place, with a few ideas, even the beginning investor who is starting out with only a small amount of money can follow a few basic steps to diversifying a small stock portfolio.