Managing a Diversified Portfolio

There\’s a regular topic of conversation in investing circles around managing a diversified portfolio and how many stocks an investor should own to be sufficiently \’diversified\’. The general consensus seems to be that portfolio diversification runs on a spectrum of portfolios with 10 or less stocks being super concentrated \’high risk, high return\’ and 40 or more being \’deworsified index trackers\’, with the optimal level being somewhere around 30 companies.

What is a Diversified Portfolio

To understand how to manage a diversified portfolio, it\’s important to understand what a one actually is. At it\’s most simple, a diversified portfolio is one which is comprised of different assets which perform different ways under different market conditions. By owning a broad range of asset types you limit your exposure to a single risk and in theory, protect against those indvidual risks wiping out your portfolio. For example, if you owned nothing but UK gambling companies and the UK Government made gambling illegal, the companies would all take an enormous hit to profits, the share prices would collapse and your portfolio would collapse with them. A diversified portfolio would instead hold other types of assets, thereby reducing your overall exposure to that sector and limiting the impact that the ban would have on your overall portfolio.

Different Types of Diversification

There are a number of different ways to achieve a diversified portfolio;

  1. Diversification by Asset Class. Investing in stocks, bonds, Exchange Traded Funds (ETFs), commodities such as gold and silver, as well as holding cash within your portfolio all help to diversify your portfolio as these assets tend to perform in different ways over time. For example, bonds tend to be less volatile than equities but also have less long-term growth potential (hence the name \’fixed income\’).
  2. Diversification by Company Size. \”Elephants don\’t gallop\” goes the famous saying – the implication being that mega-cap companies (those valued at tens of billions of pounds/dollars/euros) tend to grow very slowly compared to smaller, newer and more innovative companies. On the flip side, when recessions hit, these \’small caps\’ can often come crashing down as they fail to keep up with lofty expectations.
  3. Diversification by Geography. Don\’t assume that your home market is the best place to invest. By investing around the world, you help to ensure that part of your portfolio will do well, even if another isn\’t – for example, in 2008, the UK economy was entering a heaby recession, countries including China and Japan were much less affected.

At the moment, I hold just under 30 listed companies and 4 investment trust/collective investment vehicle that are invested across 10 sectors and do business around the world. I manage a diversified through the following process;

Monthly Review

Managing a diversified portfolio doesn\’t mean that I make wholesale changes; it\’s more of a gradual process. I set a date once a month to undertake a \’portfolio review\’ where I check each company\’s finances and progress, and make a decision to buy, hold or sell. I don\’t \’ignore\’ a bad trend and don\’t \’pretend\’ to have made a decision by doing nothing. If I want to hold, I make it a conscious decision rather than just by default of taking no other action. Likewise, I\’m constantly looking at my asset diversification – how much am I allocating and where to?

  1. Check for quality. If I\’ve already made the decision to buy this company then I want to see them growing revenues and profits, reducing debt (if they have any), and hopefully increasing their dividends. I generally look to see this trend over 2-3 years as a minimum – if a company falters, then it\’s not an automatic \’sell\’ signal.
  2. Check for value. Just because a company was good value when I bought it, it doesn\’t mean it still is now. If a company quadruples it\’s share price in 6 months without quadrupling revenues and profits, it\’s P/E value will shoot through the roof. I\’m averse to holding companies on a p/e of more than 20 (not an absolute rule, but a guide) and anything with a yield lower than 2%.
  3. Compare against other options. What else do I hold that might be a better investment? Is there anything in the market that I\’m watching and want to move into?

On-going Research for Managing a Diversified Portfolio

I register to receive company updates directly as soon as I invest in a company. The first thing I do in the morning is to review any news, financial forecasts or trading updates on the way to the office. This supports my understanding of my investments and helps me to evaluate if any of my companies should be sold or added to. Sadly, some company updates are a little less understandable than others but I always persevere and keep going over them until I\’m sure I understand what is being said.

I also have a \’watchlist\’ of companies I\’m considering investing in and like to really understand them in-depth before making a decision. I want to understand the following issues to determine if they paint a positive picture. If they don\’t, I\’ll immediately reject the company – no point wasting time thinking about sub-optimal companies.

  1. What they do
  2. How they make money
  3. How they use debt
  4. Their valuation
  5. Any potential risks
  6. Trading history
  7. Brand perception
  8. Leadership team credibility

Understanding your holdings is an essential part of managing a diversified portfolio. These steps require something I fear a lot of amateur investors shy away from because they\’re hard work. It\’s much more fun to watch a film, play a video game, or go for a pint than spend a few hours a week pouring over trading updates but this is one of the key reasons I feel so comfortable \’holding\’ through market volatility. By building a really detailed understanding of my companies, their strategy and most importantly their financial resilience, it\’s far, far easier to hold through temporary market panics and routs.

Sign up to receive the latest content, fresh from the press.

I don’t spam! Read our disclaimer for more info.