Healthy Diversification vs. Unhealthy Diversification

Many young traders share screenshots of their portfolios on social media. These portfolios are not diversified. Some either put all their money into it blackberry or have a 40:60 split into Bitcoin and Dogecoin. This type of portfolio is the death knell for your money. Hedge funds feed on such trades. Many private investors exit the stock market because they suffer losses from unhealthy diversification.

What is unhealthy diversification?

There is a notion that too many different stocks mean that your portfolio is over-diversified. The most common mistake investors make is looking for the top stocks. Then they buy them without understanding those stocks. And if the stock falls, they panic and sell the dip. Great investors like Warren Buffett understand the business and its opportunities and challenges before investing in a stock.

The second common mistake with diversification is that investors will only buy into one sector or trend. This is known as sector bias. For example, John loves dividends and is optimistic about energy. So his portfolio contains all types of energy stocks like Enbridge, Northern land power, and Suncor energy. This portfolio will generate good returns during a recovery. But it is precisely this portfolio that will fail in an energy crisis.

Then what is healthy diversification?

A healthy diversification makes your portfolio robust. Such a portfolio outperforms the market during the uptrend and also mitigates the risk of a downtrend. The question now is how do you achieve healthy diversification? It depends on four factors:

• How much time you can invest.

• The money you can invest.

• The money you want to make (financial goal).

• How much risk you can take.

You should consider your age, debts, expenses, number of loved ones, dreams, and other things. You can have more than one goal: a mix of short, medium and long term investment horizon. Each portfolio must contain four types of stocks:

• Dividend stocks like Enbridge can secure your passive income.

• Growth stocks to like Lightspeed POS can help you outperform the market and make short term profits.

• Resilient stocks like Descartes systems can give stable growth.

• Speculative stocks / recovery stocks like Hive blockchain technologies are very volatile. You can double your money in small growth phases. Therefore, it is imperative to post winnings if it is still possible.

Depending on your risk profile, you decide how much money to invest in certain stocks. Even if you are a risk taker, invest more than 50% of your portfolio in dividends and resilient stocks and no more than 10% in speculative stocks.

The story goes on

Two stocks for a well diversified portfolio

A good dividend stock is ECB (TSX: BCE) (NYSE: BCE). The company has Canada’s largest telecommunications infrastructure with regular cash flow through subscriptions. It invests in the 5G infrastructure and increases internet penetration. A new technology demands a higher price. In addition, 5G will connect many more devices to the internet and increase subscription volume. This shows that BCE has the potential to continue to distribute incremental dividends in the 2030 decade.

BCE has a dividend yield of 5.7% and was growing Dividends at an average annual rate of 6.4%. The share has also risen 11% over the year to date and has the potential to achieve capital growth of over 100% in 10 years.

A resilient stock is Placement software (TSX: CSU). It operates as a private equity company. It acquires industry-specific software companies that serve the niche market and have stable cash flows. The mission-critical nature of these companies makes them sticky. By consolidating under its umbrella, Constellation supports these companies with the management expertise and resources they need to accelerate their growth. Some acquisitions may succeed, others may fail. But overall, they bring steady growth to Constellation. The stock is up 24.5% over the past 12 months, which equates to its average five-year return of 23%.

Investing 101: Healthy Diversification vs. Unhealthy Diversification first appeared on The Motley Fool Canada.

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The fool Puja Tayal has no position in any of the stocks mentioned. The Motley Fool owns shares of and recommends Constellation Software, Enbridge, and Lightspeed POS Inc. The Motley Fool recommends BlackBerry.

2021

source https://dailyhealthynews.ca/healthy-diversification-vs-unhealthy-diversification/