Build an Investment Strategy Step #2 Risk Tolerance

 

 

Last week, I started a new investment series called “Build an Investment Strategy”. All my readers have made at least one trade in their broker account, but it doesn’t mean they have a solid investment strategy. It goes far beyond a simple set of ratios and metrics that you enter into a stock filter. An investment strategy is your philosophy; it describes the way you intend to manage your portfolio. The investment strategy is useful when you are about to make a tough decision: to buy or to sell.

 

Last week, I covered the first step: why do you invest? Answering this simple question will tell you a lot about the strategy you will use to manage the account. Today, I’ll be writing about adapting to your tolerance for risk within the portfolio.

 

I’ve already covered the whole “create your investor profile and invest accordingly” within my newsletter. This is step #2 in an exclusive investing series for my subscribers. Click here to subscribe to my mailing list.  Therefore, this article is NOT about your investor profile. If you buy stocks, we will assume you are already well aware that there are more risks with stocks than with GICs… risks of making money of course! Hahaha! I’ll talk more about how to manage this risk within your stock portfolio as all companies weren’t created equal.

 

Manage Your Risk within Your Stock Portfolio

 

When an investor is ready to invest in the stock market, he is also ready to lose money. Technically, you could lose 100% of your investment in a stock if you make the wrong decision. However, if you select sound dividend stocks, chances are you will not see a zero dollar value next to one of your stocks. Therefore, we are talking a little bit more about market fluctuations than risk of losing all your money.

 

Still, you can decide to take on more risk with some stocks than others. You can build a “safe” portfolio including several consumer (defensive) stocks and well managed REITs. Retirees and those who are looking to generate immediate revenue from their portfolio are more likely to select these kinds of stocks. There are several “safe lists” in the dividend world. You can pick stocks that have been consistently increasing their dividend payments for the last 5, 10, 15 and even 25 years. The Dividend Achievers, Dividend Champions and Dividend Aristocrats are three lists that include companies that have been paying dividends for X number of years. This does not guarantee your investing success but it’s a great place to start if you are looking for safer stocks.

 

On the other hand, you can decide to pick stocks with higher risk, but higher reward potential. For a dividend investor, this type of investment can be achieved through two different techniques: picking high yield dividend stocks or picking companies with higher growth potential.

 

High Yield Dividend Stocks

 

Adding high yield dividend stocks in your portfolio will generate higher revenues, but you may lose money in the stock value of your portfolio. There is always a reason why a company pays a 7-10% in dividend compared to another one paying 2-4%. Most of the time; it’s because the company doesn’t show strong fundamentals. Some companies have been paying a high dividend yield for years and investors are laughing at my investment strategy. But some others have tanked faster than a rock thrown in the lake. I’m not a big fan of this strategy and this is why you won’t find high yield dividend stocks in my dividend holdings.

 

Higher Growth Potential

 

I must admit, picking stocks with higher growth potential than high dividend yield is more my thing. I’ve successfully done it in the past with trades on Seagate Technology (STX) (sold), Apple (AAPL) (still in my portfolio), Walt Disney (DIS) (in my portfolio) and Gluskin & Sheff (GS.TO) (in my portfolio). These three stocks that are still in my portfolio don’t even pay 3% in dividends. However, I’m +30% (Apple), +25% (DIS) and +11% (GS.TO) without counting the dividends with less than a year owning them. I bought these three companies for the same reason: they show strong growth potential. The thing is that they are riskier as well. I took the bet that Apple will continue to dominate the cell phone industry, that Disney will continue to dominate with ESPN and will make tons of money with their movies and that Gluskin & Sheff will continue to outperform the wealth management industry (and hopefully will be bought out by a bigger firm).

 

If I’m wrong, I’ll also pay the price. You don’t have this kind of dilemma with a “boring” stock like Kimberly-Clark (KMB), Coca-Cola (KO) or Procter & Gamble (PG).

 

My Strategy to Manage Risk within My Portfolio

 

I love dividend investing because it helps me save time when managing my portfolio. But pure dividend investing is often synonymous with buying and holding the same companies forever. This is kind of boring and I don’t want to follow this path exactly. This is why I have come up with a hybrid strategy that manages risk in my portfolio while offering me the opportunity to trade a few times per year.

 

This is why I’ve separated my portfolio into two parts: The Growth portfolio and The Core portfolio. The goal with the core portfolio is to follow a dividend growth model and invest in stocks I intend to hold for several years, if not forever.

 

The growth portfolio enables me to trade once in a while. These stocks are on my “close watch list” and I can buy or sell them at any time once I figure I’ve made the money it can produce. For example, this is how I dropped STX at $40 (put a stop sell). I could have rode it to $60,  but you never know what it going to happen! So I’m closely watching the following four stocks and could trade them out of my portfolio at any moment. The core portfolio should remain stable for several years.

 

 

I like having two sides to my portfolio as there is nothing more exciting than buying a new stock or selling one for a good profit! It happens too rarely with my core portfolio so I had to find something fun to keep my interest towards stocks.

 

Now that we have covered the “blah blah” around the strategy, the next post will be about writing down your investment strategy with numbers and a clear method. In the meantime, I’ll publish the Ex-dividend dates and 2014 Best Dividend Stocks result. So stay tuned!

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