While individual stock selection gets most of the airtime, organizing those stocks into a high performance, resilient portfolio is equally important. This aspect is referred to as diversification, but it is bigger than that. Some may think owning a number of companies in a couple different sectors qualifies as diversification. However, the market tends to move sectors together and those who invest narrowly may ride the wave for a while but could drown in the whitewater after the wave breaks.
The financial industry divides companies into 11 sectors. The chart shows each sector weighting in the S&P 500 and the TSX. These weightings change over time. For instance, in 2008, energy made up 30 per cent of the TSX and 14 per cent of the S&P 500, it declined precipitously and then recovered somewhat to its current level.
Eschewing conventional protocol, I divide companies into three groups and 17 sectors. The first group tends to be high-dividend-paying, stable companies that form the foundation of a solid portfolio, and includes banks, non-bank financials, communications, pipeline and utilities. The indices lump pipelines with energy, which seems bizarre given the stable cash flow nature of pipelines and the highly volatile nature of oil and gas.
The second grouping is the higher-growth industries of health, consumer, industrials, technology, transportation, infrastructure and construction, real estate and business services. This group has lower dividends and higher-growth profiles, strengthening returns over time.
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My resource grouping is volatile by nature and includes sectors of oil and gas, metals and materials, precious metals and alternative energy/environment.
All sectors have high-risk speculative companies and low-risk conservative companies. It is important to understand the sector doesn’t define whether a company is speculative or conservative.
I try to have a company from each of the 17 sectors in each portfolio. With a motto of “go to where the value is,” I build weight in sectors currently out of favour, then transition as sentiment changes to focus on areas that have moved out of favour. It can take a long time for sentiment to change and, when it does, it can change fast! Over the past year, many tech firms have been halved while energy companies have doubled.
If you can predict the future, this level of diversification may not be necessary, but given my inability to do so, I prefer this approach to building portfolio resiliency. At the time of writing, my performance this year has been flat, whereas the U.S. market has been down significantly. This can be partly explained by the addition of energy over the past out-of-favour years, while avoiding speculative in-favour technology stocks.
Bridging into the next success factor, one of the craziest market myths is new, young investors should gravitate to high-risk companies because they have lots of time to recover from losses, if they occur. While technically correct, many will abandon the whole stock investing field after getting burned. It is much better to follow the crawl, walk, run progression than attempting the reverse. The Titanium Strength Portfolio is dominated by the first grouping of companies, which are unlikely to disappoint, setting a new investor up to experience success from which to build.
Managing yourself
This most important factor will garner the fewest words. We all have character traits that will help us perform well and those that will hurt us. We need to take advantage of the helpful ones and manage the hurtful ones. For instance, with my Dutch heritage, a helpful trait is being cheap, with my apologies for stereotyping. I don’t like to overpay! Adding in a farming background makes me cheap squared (C2 for mathematicians). However, I am neither calm nor patient, both of which are good traits that help avoid over-trading and overreacting. Therefore, I must manage those aspects of my personality traits.
Disciplined, thoughtful, skeptical, independent thinker, flexible, perpetual learner, confident and methodical are other positive traits for investing success. Overconfident, status seeking, trendy, trusting, emotional and amenable could be negative traits. For example, if you always want to buy the latest trendy fashion, it might indicate that you will buy the latest trendy stocks — a trait that needs to be managed. As my wife will attest to, I’m OK with a 20-year-old shirt!
All four success factors work together. Someone who understands market behaviour, with a well-built portfolio of strong companies, is less prone to emotional decisions, even if they normally exhibit emotional behaviour.
