How Should You Diversify a $10,000 Portfolio?
Brian is a member of The Motley Fool Blog Network -- entries represent the personal opinion of the blogger and are not formally edited.
New age diversification is investing in the 21st century, and understanding that very few have the patience or the discipline to buy, hold, and forget for decades at a time.
In today’s information age, people like to be active, and follow their investments closely. Thus, new age diversification allows each investment to serve a purpose in your portfolio.
In my book, Taking Charge With Value Investing (McGraw-Hill, 2013), I discuss this topic from all angles, from types of investment, industries, portfolio size, goals, etc., but in this piece, I am looking at a very specific investor; those with a portfolio of $10,000, or an investor who is just starting out.
Preparing to buy & finding your goals
If you are investing $10,000, chances are you are a fairly new investor, and are willing to take larger risks for larger rewards.
In theory, as wealth grows, so does your avoidance of risk. Personally, I know all about this “theory.” Looking back 15 years, it’s a wonder I didn’t go broke, as I took risks that I wouldn’t even consider today.
The idea of having a smaller portfolio is knowing that your goal is to grow, but also taking calculated risks that will still leave you well diversified and protected.
What to buy?
With $6,000 invested into Best Buy and Apple combined, this portfolio would have 60% of its holdings returning a dividend yield of almost 3%.
Many might say, “why Best Buy?”
It is a logical question, but aside from it being a retail holding, the company is very cheap at just 0.20 times sales. It also has catalysts to produce additional gains, with its new store-in-a-store concept and online sales tax that could boost its sales.
Mant might say, “why Apple?”
Apple trades at just seven times next year’s earnings minus cash and has a price/sales ratio of just 2.30; both of which are at least 50% less than competitor Microsoft. Moreover, Apple is growing faster than Microsoft, but is cheaper due to it being in a natural transition between growth and value.
The transition from growth to value is something I often discuss, and I believe is very important for investors with small portfolios seeking large gains. In a sense, these are stocks that can be purchased for prices that are illogical.
Netflix, Green Mountain Coffee Roasters, and even Best Buy are examples of transition stocks. It occurs when a company is expensive as a growth stock, but then falls as it becomes more stable.
Best Buy and Apple are at two completely different ends of the spectrum in this “growth to value” cycle. Best Buy completed the cycle when its growth slowed and its stock slid from over $50 to under $15. At $50 it was too expensive, but at $15, it was too cheap. Now, investors can capitalize on its appreciation.
Apple’s hyper-growth model has slowed, and the market has responded negatively. But much like Best Buy, Netflix, and Green Mountain Coffee Roasters, the value present will eventually respond as gains. Hence, while technology and retail are two different industries -- providing diversification -- these two stocks are at different stages in their trade.
Regeneron Pharmaceuticals is a part of the hyper-growth biopharmaceutical space, which is one of the most promising in the market. Biotechnology tends to trade apart from the market, meaning market direction doesn’t always dictate the performance of biotechnology; thus providing security.
Sure, Regeneron is expensive at 14 times sales, but with a massive pipeline that consists of blockbuster products, Regeneron’s long-term outlook is still promising. Moreover, while Best Buy and Apple provide value to your portfolio -- although different levels of value -- Regeneron gives you growth.
The idea of “new age diversification” is for a portfolio to evolve with goals and worth. It is also the process of trying to include stocks that all serve a different purpose.
Best Buy is a retail stock in the middle of an uptrend after transitioning from growth to value.
Apple is a tech stock at the bottom of its trend while transitioning from growth to value.
Regeneron is one of the hottest plays in biotechnology as a hyper-growth company.
Hence, if these three stocks don’t provide diversification to a small portfolio, then nothing else will!
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Brian Nichols owns shares of Apple and Regeneron Pharmaceuticals. The Motley Fool recommends Apple. The Motley Fool owns shares of Apple. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy. Is this post wrong? Click here. Think you can do better? Join us and write your own!