Step 5: Diversification
Whether you employ fundamental analysis or technical analysis, there are no guarantees in investing.
No matter how well you analyse stocks, at some point you will be on the losing end of a share price movement. That's where diversification comes in.
A rule of thumb is that you should have around eight to 15 stocks in a personal portfolio – enough to give you adequate diversification without the monitoring of those shares becoming too big a task.
It's important that those stocks are spread across a variety of industries, so there isn't too much 'correlation' in their ups and downs. Having four utilities stocks and four bank stocks certainly wouldn't constitute diversification.
If you have a dozen or more stocks, in theory a loss on one of them should be more than offset by the gains in the others.
In selecting stocks, don't try to be a 'bottom picker' (an unglamorous term). Advisers like to say it's not 'timing' the market that matters, it's 'time in' the market.
Even the professionals find it hard to know exactly when a market, sector or stock is as cheap as it's going to get.
Wait too long to buy and you'll miss opportunities. (By the same token, wait too long to sell and you could miss the peak and be undermined by a reversal.)
Use your head and try to keep emotion out of your investment decisions. In particular, know when to cut your losses and sell. Don't be stubborn and stick with a losing stock.
And don't forget to review and rebalance your portfolio regularly.
If you're still worried about which shares to put in a portfolio, you could try establishing a 'dummy' portfolio – a dozen or so shares that you don't actually buy but pretend to own, monitoring the ups and downs for a few months to see how you go.
Alternatively, form an investment club with friends also interested in learning more about share investments – it spreads the risk and the research task. But be aware that you won't always agree.
Create a shares watchlist
Make sure your stocks come from a diverse range of sectors. The ASX uses these sectors:
- Consumer discretionary
- Consumer staples
- Financials excluding property trusts
- Gold sub-industry
- Health care
- Information technology
- Metals and mining
- Property trusts
- Telecommunication services