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Investing’s a Manageable ‘Risky Business’

Keep Your Balance With a Mix of Company Sizes, Industry Types

 Douglas  Gerlach Bookmark and Share

Investing in the stock market is risky business. Although admittedly not in the same category as the “risky business” in which Tom Cruise’s character found himself embroiled in the 1980s film of the same name, buying and selling stocks carries a significant level of risk nonetheless.

Investors and clubs use several strategies to keep the risk in their portfolios at a manageable level. Analyzing stocks with tools such as the Online Stock Selection Guide or Toolkit 6 to find high-quality, well-managed companies is a great place to begin.
The real key to managing risk in a portfolio of stocks is to spread out the holdings in two ways: by size of company and by sector and industry.
A portfolio that includes stocks from many dissimilar sectors and industry groups helps reduce risk by lessening the impact of problems that might affect a single company or an entire industry. In 2000, clubs that had overloaded on technology stocks were shocked when their portfolios took a tumble during the dot.com crash, while energy companies held their own.
Banks and other financial institutions were knocked for a loop at the start of the current recession and financial crisis, but health care companies were less likely to be affected by the credit meltdown.
By holding stocks from companies of varying sizes, you can reduce the overall volatility of your portfolio. Companies of different sizes tend to grow at different rates: Small companies tend to grow more quickly than large ones and thus can generate higher returns, but they may be more volatile; meanwhile, large companies may grow more slowly than small ones, but they’re less volatile and may pay a dividend that often provides a measure of safety.
Mid-sized companies are right in between: They  tend to generate returns that are higher than the overall market but often less risk than smaller businesses.
In addition, small and large companies have a high degree of market performance noncorrelation. This means that when large companies are doing well, smaller companies tend to underperform the market, and vice versa.
Coming out of a recession, small companies tend to outperform large ones for up to three years. This adds a reason that clubs should be beefing up their small-company exposure right now.

BetterInvesting categorizes companies by the size of their annual revenues: Mid-sized companies have annual revenues between $500 million and $5 billion. Thus, small companies are below $500 million and large companies greater than $5 billion. BetterInvesting suggests that investors and clubs aim to build a portfolio comprising 50 percent mid-sized, 25 percent large and 25 percent small companies.
Unfortunately, many clubs ignore or are unaware of these guidelines. I frequently see club portfolios that are overweighted with large-company stocks, often from consumer-goods companies or businesses with well-known brand names. These unbalanced portfolios are providing another kind of risk for these clubs — the risk that the portfolios will significantly underperform the overall market.
Using tools such as the Porfolio Diversification charts and reports on myICLUB.com can help clubs easily manage the distribution of their stocks by company size and sector/industry. In the Reports section of the site, look in the Portfolio Reports and Charts sections for links. Then, before making a club purchase, ask how the new stock will fit with your current holdings. If the new stock doesn’t fit with your club’s diversification objectives, reconsider the purchase and seek out stocks that fill gaps in your portfolio.
Clubs that pay attention to the diversification in their portfolios can turn the “risky business” of investing into a “rewarding business” and a better chance of generating long-term gains.


Douglas is ICLUBcentral's product manager, helping develop the company's programs including Toolkit 6, myICLUB.com, and the Investor Advisory Service. He is also the author of several investing books, including The Pocket Idiot's Guide to Direct Stock Investing, The Complete Idiot's Guide to Online Investing, The Armchair Millionaire, and Investment Clubs for Dummies.

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