It’s Canada, so your choices among the bigger-cap stocks are somewhat limited, but you know you want to be represented in four key sectors: financials, telecoms, energy/resources and metals/mining. You’re think of buying four stocks, plopping $25K into each of them and then sitting back to wait for the upside fireworks.
Here’s a tip: Don’t. Don’t buy just four stocks from those four key sectors – buy 12 of them, three from each sector.
Here’s why: If you buy one stock from each sector, you may very well have achieved a minor measure of equities diversification and you may feel as though your equities investing assets are reasonably allocated. And yes, you may, to a degree, have mitigated the so-called “sector risk,” given that you are represented in four key sectors of the Canadian economy.
But here is what you haven’t done: You haven’t done anything to alleviate the “stock risk” part of that equation. You have placed just four eggs into your stock basket – and any one of them could pull a Humpty Dumpty at any time and without any warning. Your four eggs in a basket might just become a sloppy stock omelette!
Here’s an example to make the point: Investors who have had all their eggs in a major global insurer such as Manulife for the past few years have taken a brutal beating. Now, Manulife is a respected, well-managed company, but there isn’t a management team in the world that could have saved Manulife from the twin horrors of the 2008 global financial meltdown or the persistence of low interest rates that has taken such a toll on the company’s financial obligations. The $25K that you might have invested in Manulife back in 2008 would be worth something in the order of $8K today. That’s not good, either for you or your portfolio.
Now, let’s say all those Manulife investors had taken a more cautious route with their insurer-earmarked stock holdings. Let’s say they didn’t dump a full $25K into Manulife, but instead, back in 2008 at the stock-price highs, had spread the risk around by adding Great-West Life and Industrial Alliance to the mix, all three stocks in equal measures.
Today, whereas Manulife stock is selling at less than 33% of its 2008 high, Industrial Alliance is selling at approximately 75% of its 2008 high; Great West Lifeco, for its part, is selling at 67% of its 2008 high. All three are losers, to be sure, but investors who bought equal parts of all three insurers are vastly ahead of those who dumped all their eggs into Manulife’s fragile basket. That’s largely because Industrial Alliance and Great West are more domestically inclined and were therefore less exposed to the wreckage of the global meltdown.
Run a test for yourself with the telecom/communications stocks using, say, BCE, Rogers and Telus, Canada’s three dominant players. Do you want to make a one-stock bet as to which of those three companies will be the long-term winner in the consumer marketplace? Do you want to run the risk of being dead wrong? Or would you rather spread the risk around buying all three – all with attractive dividends and all with the potential for further stock-price gain.
Here’s our view: Buy them all. Collect the healthy dividends. And then sit back and let the future unfold as it inevitably will. In time, you may well find a Humpty Dumpty cracked egg in the basket – chances are, you won’t find three of them.
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