Diversification

In the past few months, I've been reading and learning about how to do fundamental analysis of a stock to determine its growth or value potential. I did some analysis of a few stocks listed on the TSX, and I came up with 15 potential growth candidates. I haven't done any deeper analysis yet, just some initial weeding out of stocks that didn't fit my basic criteria.

I decided to create a new portfolio in Google Finance and add my 15 hopefuls to it, just to see which ones outperformed the others. I added hypothetical transaction data to each stock so that the cost basis was around $500 for each one. This is my personal minimum amount to invest in a stock, since it makes brokerage fees around 1% of the total amount being invested. All in all, my hypothetical cost basis was around $7,700. In the two weeks since I started the portfolio, it has gone up to +3% and is now around +1.6%. While it's true that two weeks is a very short time frame for growth investing, I realized something as I checked on the portfolio every day.

I have read many times before how diversification in a portfolio is essential for mitigating concentration risk. I didn't actually realize the true value of diversification until I saw it in action. The worst of my 15 picks is currently down $62. However, my overall portfolio is up by $63. Just under half of my picks are in the red by small amounts, but from diversifying across multiple stocks I have managed to keep the overall portfolio value positive.

Since this is all hypothetical, it's purely for the sake of learning on my part. However, it made me re-examine my current strategy for my real stock portfolio. Up until now, I've been working on building a dividend growth portfolio. The dividend growth strategy is a valid strategy, however it takes a fair amount of capital before the dividends start to really pay off. The dividend growth strategy also takes patience, which I don't seem to have when I say that I'm considering switching strategies.

I have two excuses for moving away from the dividend growth strategy for the time being. Firstly, my whole investing experience so far has been all about learning as much as I can, both by reading about the vast amount of things there are to know about investing, and also to learn by doing. Learning investing through hands-on experience was my inspiration for starting this blog in the first place. Secondly, as I mentioned above, it takes a significant amount of capital to earn meaningful dividend amounts through a brokerage account every so often. It's a little different if you buy shares direct and can hold fractional shares, but that's not the case for me.

So after taking a good look at my diversified pretend portfolio, I saw the true power of diversification and the role it plays in growing your money. Since I have a very limited amount of money to invest with, I decided to try and grow my account more efficiently and effectively. Perhaps a few years down the road when I have more income available and a larger balance in my TFSA, I can consider re-implementing the dividend growth strategy.

If I want instant diversification and my TFSA is a discount brokerage account, what's the first thing that comes to mind? ETFs! I did a little research on what types of ETFs are available on the TSX, and what sectors and market caps they cover. I came up with a few choices and put them into a new hypothetical portfolio in Google Finance. Then I scrolled down to the portfolio performance window, and checked off the box for comparing portfolio performance with that of the S&P/TSX index. As it turns out, my ETF choices outperform the S&P/TSX by almost 10% over the past 12 months! I have yet to examine the risks associated with each ETF, and I also need to decide what percentage of my portfolio each ETF should occupy. I'm excited to try out a new strategy, and I've now given you fair warning for the types of posts you might see on this blog in the near future.