What Makes a Good Stock Portfolio?

A good stock portfolio has three objectives. The first is that the portfolio is diversified by holding a number of stocks in a variety of industries and sectors. The second is that the portfolio acknowledges risk by having a clear-cut system for buying stock, selling stock, and limiting risk throughout the period of ownership. The third is to maximize the return to the portfolio owner through judicious knowledge of companies' prospects and their ability to meet goals.

Diversification by Sector and Industry

Standard and Poor's uses ten stock sectors and each represents a collection of industries producing similar or related products. Sectors include energy, financials, health care, consumer discretionary, consumer staples, materials, industrials, information technology, telecommunications, and utilities. Investors develop strategies to pinpoint the best returns by sector based on earnings and improving fundamental factors. From the sector and industry categories investors choose the leading one or two stocks in each group to purchase.

Diversifing Risk in a Good Portfolio

Good portfolio management requires that diversification be an important part of investing strategy. Diversification is the purchasing of stock among a variety of sectors but also a diversity of management styles and corporate size. A balanced stock portfolio owns small-capitalization stocks (companies under $1 billion in size), mid-caps (from $1 to $3 billion) and large-caps (over $3 billion). The savvy investor is looking for very strong balance sheets and high asset values (value investing), stocks with high earnings potential (growth stocks), and stocks with large international exposure (large-cap investing) that also diversifies currency risk.

Buying and Selling Stock

Strong portfolios eliminate the drama of holding stocks. Before purchasing a stock, the investor must have a plan. Strong portfolio management includes a fundamental analysis of a stock's price possibilities and a technical approach of when to enter into a trade. Technical analysis may be in the form of moving averages or sharp rises in the volume of stock traded, for example. Sell points may be through price targets, declining volume, a percentage decline in price, or a sideways trading pattern of the stock.

Limiting Losses and Maximizing Gains

Traders set limits, usually no more than 8 percent of the value of a trade, before they will sell the stock. Limit losses, or stops, are very important. Limit losses prevent small losses from become large losses. Not having a stop-loss plan is the biggest trading mistake when building a good stock portfolio. Traders also have sell points that, when reached, trigger the sale of the stock. Typical sell points are a slowing rate of sales, stock prices that fall below the lowest low of the last 20 days, or stocks that fall below the 200-day moving average.

Good Stock Portfolios Trade Minimally

Two portfolios that are held for 20 years with returns of 7 and 10 percent will have greatly different ending values. The portfolio with a 10 percent return will have nearly twice as much as money as that of the 7 percent return. Investors should realize that with commission costs and fees, and the difference between the bid and offered side, constant trading can easily cost 3 percent or more of a portfolio's funds. Investors should keep trading to a minimum and use low-cost online trading accounts in order to reduce trading expense. Investors should also reinvest all dividends in more stock as they are received. These two steps alone should account for an added 3 percent portfolio return.

References

• S and P Sector Groupings
• Excellent Trading Resource (Ed Seykota)

Resources

• Stocks to Own