In part 1 of this series titled “How Many Stocks Should I Own?” found here, I focused primarily on how many stocks an investor might need to hold in a stock portfolio for adequate diversification. In this part 2, my focus will shift to category selections.
Instead of how many stocks to own, this part 2 relates more to what is the best way to design or construct a common stock portfolio? This is a question I am often asked, and my short answer is always the same – it depends. The truth is, there is no perfect method or strategy for designing a stock portfolio that is right for every individual investor. However, there are principles of sound investing that every investor can follow and apply when designing a common stock portfolio that’s just right for them.
Furthermore, there are general categories that individual investors fall into. Some individuals are young and planning for retirement while other individuals are closer to retirement, and there are some that are already retired. Additionally, each individual investor has different levels of financial resources that specifically apply. To complicate the process, even more, individual investors of all types possess unique goals, needs, objectives and risk tolerances. Therefore, the logical secret to designing a successful common stock portfolio is to design one that’s most appropriate for you.
Therefore, the objective of this series of articles is not to attempt to dictate how individuals should design their own stock portfolios. Instead, the objective of this series is to provide information regarding common stock investing strategies and options that everyone can evaluate and ultimately utilize so they can implement and construct a common stock portfolio that’s just right for them.
At the end of the day, it comes down to making the appropriate choices. The most appropriate choices include, but are not limited to, utilizing the most suitable categories of common stocks available as well as the appropriate mix. In one context, the choices approach the infinite, and this can be confusing or even overwhelming. On the other hand, the options can be generally categorized, thereby simplifying the process to a more manageable level.
Of course, individual investors also have the option of engaging professional help or self-directing their own stock portfolios. This can be done directly by hiring outside professional managers or by investing in packaged products created by professional managers such as mutual funds or ETFs. However, this series of articles is intended for the self-directed individual investor interested in designing and managing their own common stock portfolios. Importantly, this is not about their overall portfolio, just the common stock part.
Stock Selection: What Are the Choices?
On the US stock exchanges alone, individual investors have almost 20,000 individual stocks (companies) to choose from. No matter how diligent you could be, it would be impossible for any individual to conduct a comprehensive analysis of all of them. Therefore, individual investors need a method of separating the wheat from the chaff.
One effective way to accomplish that is to break the larger list down into broader categories based on specific characteristics and attributes. In his best-selling book “One Up On Wall Street,” renowned mutual fund manager Peter Lynch presented what he referred to as “The Six Categories.” Personally, I believe that Peter Lynch provided a succinct summary of the broad categories or types of common stocks available for investment consideration.
However, his six categories are very broad, and therefore, within each category, there are many additional nuances that investors are best served to recognize and understand. Nevertheless, I believe that Peter Lynch provided an excellent foundation with his presentation of the six broad categories available to investors. To clarify this important distinction further, I turn to Peter Lynch and his own words with the following quote:
“There are almost as many ways to classify stocks as there are stockbrokers – but I found that the 6 categories cover all of the useful distinctions that any investor has to make”.
