Why this trusted strategy could lead to a dog's breakfast of a portfolio


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Investors have been told for decades that they need to sector invest in order to balance their portfolio across multiple sectors to achieve a good return. However, in these times of modern technology and high frequency trading, does this strategy still apply?

The theory is based on the concept of investing in sectors that counterbalance other sectors that are likely to underperform in order to balance out the portfolio.

While on the surface this may seem like good advice, all it really does is limit the potential profits that are achievable because you are holding onto stocks in the portfolio that are falling.

investing strategy dogs breakfast

This practice also leads investors to hold over-diversified portfolios of 25 to 40 stocks that look more like a dog's breakfast than a properly constructed portfolio.

Anyone holding this many stocks in their portfolio knows that for the most part, one third is rising while the remaining stocks are moving down or sideways with the portfolio achieving average to poor returns, but this needn't be the case.

If all an investor did is to exit stocks that fall away, they would achieve a much better return. In essence, smart investing is simply about buying what goes up, and selling what goes down.

Right now, there is an influx of inexperienced investors in the market using apps to purchase stocks based on push notifications of what to buy. Unfortunately, this is resulting in a complete disregard for proper portfolio construction as the majority of their money is being invested in a small number of sectors, which is a very risky strategy.

From experience, I always recommend that you hold between five and 12 stocks and to only invest in stocks that have the potential to rise.

Best and worst performing sectors this week

Materials has been the best performing sector so far, up more than 3% with BHP, RIO and Fortescue Metals all rising strongly. Utilities and Consumer Discretionary have also performed well as they are both up more than 2%.

The worst performing sectors include last week's big mover, Technology, which is currently down more than 3% followed by Healthcare which, is slightly in the red for the week while Communication Services is just in the green

Looking at the ASX top 100 stocks, the best performers were, once again, all resource companies with Whitehaven Coal, Fortescue Metals and Alumina all up more than 8% so far this week.

The worst performers include technology stock Xero, as it is currently down just less than 4%, which may be an indication that its stellar rise could be ending. Next is Evolution Mining down more than 3% and Orora Ltd down just less than 3% so far this week.

What's next for the Australian share market

Once again, the All Ordinaries Index is still lacking any real direction as it continues to trade up one day and down the next. This week the bulls have pushed the Australian market slightly higher, but it remains to be seen if this will continue to break the current sideways pattern the market seems to be in.

Since June 1, the Australian stock market has risen just 4%, as the market is quite nervous given the US is now releasing second quarter earnings reports. If there is any bad news in these reports, we are likely to see the Dow Jones drop and a ripple effect flow on to our market.

I still believe there is time for our market to rise over the next few weeks to trade to around 6600 points, which is due to occur in the next two to four weeks.

That said, as I mentioned in my last report, if the bears take hold of the market, then we may have already seen the yearly high and we need to expect further falls. For now, until the market picks a direction, it is best to exercise caution if you intend purchasing stocks.

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Dale Gillham is chief analyst for Wealth Within (AFSL 226347). He has an Advanced Diploma and Diploma of Share Trading and Investment and more than 25 years' experience in the financial services industry.

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