Investors have been told for decades that they need to sector invest in order to balance their portfolio across multiple sectors to achieve a good return. However, in these times of modern technology and high frequency trading, does this strategy still apply?
The theory is based on the concept of investing in sectors that counterbalance other sectors that are likely to underperform in order to balance out the portfolio. While on the surface this may seem like good advice, all it really does is limit the potential profits that are achievable because you are holding onto stocks in the portfolio that are falling.
This practice also leads investors to hold over diversified portfolios of 25 to 40 stocks that look more like a dog’s breakfast than a properly constructed portfolio. Anyone holding this many stocks in their portfolio knows that for the most part, one third is rising while the remaining stocks are moving down or sideways with the portfolio achieving average to poor returns, but this needn’t be the case. If all an investor did is to exit stocks that fall away, they would achieve a much better return. In essence, smart investing is simply about buying what goes up, and selling what goes down.
Right now, there is an influx of inexperienced investors in the market using apps to purchase stocks based on push notifications of what to buy. Unfortunately, this is resulting in a complete disregard for proper portfolio construction as the majority of their money is being invested in a small number of sectors, which is a very risky strategy.
From experience, I always recommend that you hold between 5 and 12 stocks and to only invest in stocks that have the potential to rise.
Dale Gillham is Chief Analyst at Wealth Within and international bestselling author of How to Beat the Managed Funds by 20%. He is also the author of Accelerate Your Wealth—It’s Your Money, Your Choice, which is available in bookstores and online atwww.wealthwithin.com.au