Fighting losses through diversification
"Create a portfolio of 12 to 18 stocks." That's the second rule of the Bowser Game Plan, but it's arguably the most important. After all, a portfolio containing that number of stocks can't help but be diversified to some extent. When building a stock portfolio--especially a Bowser portfolio--diversification is ESSENTIAL. It will protect you against losses. However, while buying multiple stocks is key, there are two areas where particular attention should be paid to diversification: companies and industries.
Buying multiple issues means nothing if you don't maintain a certain balance. Too often investors say: "I like this company a lot. It will outperform the rest in my portfolio, so I'll invest twice the amount (or more)." But, what happens if that stock collapses? Instead of gaining double, you've lost double.
Instead, when creating a portfolio, set EITHER an equal dollar amount (say $1,000) to invest in each company, OR an equal number of shares (say 200). That way, your funds are spread equally across the board. Now, if any one company slides, your portfolio has a much better chance of staying positive or recovering quickly because that issue only made up a small portion of your entire holdings.
Side note: We often get asked which is better, dollar amount or number of shares. Quite frankly, as long as it's one or the other and stay consistent, there is no preference. Where investors get in trouble is either failing to maintain that consistency, or getting too attached to one stock and over investing.
Diversification also comes in play across industries and businesses. If an investor holds 12 to 18 companies, but they are all in the oil industry, what happens when the oil industry experiences turbulence? His portfolio is in for a bumpy ride.
However, that same investor instead holds 16 companies. 3 are in oil, 2 in precious metals, 2 in casinos and gaming, 2 in apparel, 3 in technology, 2 in pharmaceuticals, and 2 in manufacturing. Now, if oil hits a rough patch, he has 6 other industries to make up for it.
Again, it's all about balance--making sure you aren't over invested in one area of the market. There is no direct formula for selecting businesses. We try to vary our selection of Companies of the Month, but sometimes we recommend a few companies in a row within the same or similar industries. So, monitor the your investments and try to make sure you don't put all of your eggs in one basket--the basket being the industry and the eggs being the companies.
Bringing it together
Diversification is a simple idea that goes lengths in a portfolio. Especially in small stocks, where futures tend to be more uncertain and a bit jumpy, your portfolio must stay balanced amongst both companies and industries. That way, if one company or a whole industry has a bad day, week, month or year, you have a number of other companies or industries to fall back on.
Perhaps one of the biggest investing follies is throwing all of your capital at one company. You can make money if the company does really well, but you can lose all your money if the company does really poorly. In our 36+ years of recommending stocks, we have seen more stocks eventually dip into the red than stay in the black. However, those that appreciate more than make up for those that don't (as indicated by our Historical Review being up over 130,000% when adding the pluses and minuses).
So, to make a very long story quite short, do not attempt to pick just one winner. You . Instead pick 12 to 18 that could be winners. More than likely, you'll get at least one in that bunch (probably more).
The Bowser Report is a monthly financial newsletter that specializes in small stocks trading for $3/share or less. Our goal is to provide the individual investor with relevant information on microcap stocks. Each month, we recommend a new company, provide information on past recommendations and report news surrounding the microcap marketplace.
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Information in this blog post contains references to past Bowser recommendations. This blog post contains no recommendations, and instead relies on data gathered on past recommendations from sources thought to be reliable.