As any financial advisor worth their salt will tell you, diversity is one of the most important characteristics of a well built investment portfolio. Diversifying helps you to minimize exposure in case of a downturn. It is advisable to diversify not just across various asset types but also industries. According to Peter Lynch, one of the most successful investors and fund managers of his era, the investments that you should have in your portfolio to make it truly diverse should include the following:
- Slow Growers
Any company which has repeatedly increased its sales and earnings in the preceding three years but at a rate lower than GDP growth falls in this category. While slow growth may turn off some investors, it is not necessarily a negative. Slow growth companies tend to show remarkable consistency with rising earnings each year. On top of this, they also usually fall slowly during downturns. This dependability compensates for their gradual increase in value.
- Fast Growers
Growth stocks are stocks belonging to young companies that have shown a faster-than-average growth over the previous few years and are expected to continue in that trend. Tech companies such as Amazon and Google are good examples of this. Fast growers offer massive gains. However, they tend to be riskier too, which is why they shouldn’t be the sole investment in your portfolio.
Stalwarts are companies that were formerly fast-growers but have evolved into large corporations whose growth has slowed, but is more reliable. They generally offer goods or services that are always in demand, a fact that ensures strong, stable cash flow. While they may not top the markets, if acquired at a good price, they can offer growth of upto 50% over several years. For this reason, long-term investor has the most to gain from stalwarts.
These are companies whose earning trends mirror that of the economy, through expansion, peak, recession and recovery. They typically produce discretionary consumer items, which usually have high demand during a booming economy, but are the first to be cut within a recession. This seeming predictability means that it is possible to time the market and buy shares when they are in their low point and sell them at a high point. However, if a recession is severe enough, such companies can go out of business and their stocks could lose all their value.
Companies that have undergone a period of weak financial performance but which can rebound with some changes in corporate governance or business strategy fall in this category. A patient investor can reap large profits if he or she is able to identify and buy turnaround stock at low prices and hold them until they appreciate.
- Asset Play
A firm will fall into this category if investors believe that it is undervalued since its current price does not reflect the current value of its assets. An example of this is a retailer that may be performing poorly due to market conditions but still holds valuable assets such as real estate. Since they are backed by strong assets and are being offered to the market relatively cheaply, investors find them attractive.
In conclusion, when diversifying your portfolio, it is important to not only consider assets in different classes but also what category they fall into. If it is impossible to acquire assets in all six groups above, a mix of fast growers, slow growers and stalwarts is the next best thing. However, as your portfolio grows, include asset plays, turnarounds and cyclicals as well. Alternatively, invest in a fund whose portfolio combines all of the above.