Breadth in diversification

[ronn38]

I’m interested in thoughts on the role of “breath” in diversification regarding a “buy and hold” portfolio. 

As we all know, too little diversification leads to volatility and a greater potential for a severe loss of capitol, while excessive diversity creates the risk of under performance.

Personally, I’m within 10 years of using this income stream (mostly DRIP now), so I tend to place emphasis on yield without, hopefully, sacrificing quality.

My current strategy—

In building my portfolio, I have tended to purchase full positions in two 2 businesses in direct competition with one another (obviously I don’t cover all businesses). So in consumer staples I’d have KO and PEP, MDC and YUM, WMT and TGT. In telecom T and VZ (and VOD for a little international exposure).

However, I also like to use “clusters,” ether to reduce exposure risk or because I feel the sector very defensive and a staple for long term income generation. For example, to get exposure to Canadian banks, but reduce risk and volatility I bought BNS, TD, RY--using what would be 1.5 positions in a single company (say $15,000) over 3 (say $5000 each). So instead of having a position in RY, I have a position in Canadian banking—if that makes sense.

With UTS and tobacco (which I treat as UTS) I would/have buy full positions in each company; i.e. SO, DUK, D and WEP as 4 full positions (say, $10,000 each = $40,000 in UTS)). And with tobacco PM, MO and BTI as 3 full positions. Obviously, this create a larger portfolio (61 now, and about 75-80 when I’m done).

Opinions: would you think it better to hold--say $200,000--equally invested in Consumer Staples over 6-8 companies that represent competitive pairs (like KO and PEP).

OR…

Would you consider it more prudent/advantageous to simply hold much larger positions in Philip Morris International, Procter & Gamble and Wal-Mart Stores and that be your Consumer Staples holding?

$200,000 spread equally across RDS.B, CVX, XOM and BP or just XOM and CVX? (or would you say XOM, MMP and VLO and call energy covered)?

Thanks for your thoughts!

Ronn

[Dividend Watcher]

Ron, I like your thinking and if I had that much to spread around I'd probably do something similar.

Obviously, you're looking at total return whereas I'm more focused on the income stream so I think you'd be better off narrowing down your choices to just 2 or 3 in each sector versus 4 or more competitors. I have around 33 positions and probably 12 more non-duplicates in the wife's portfolio. (Just a top of the head guess there.) I'll probably trim mine back a little to add to her diversification is where my head's at right now. Of course, as I told you a long time ago, I look at both portfolios in isolation rather than as an integrated entity.

IMO, once you get much above the 40-50 range, you're going to end up being your own index fund just tracking the market. I have no studies to back that up though. Either way you'll still end up with a good portfolio.

[cannew]

When I was in the accumulation mode and getting serious about retirement, I directed my investments towards Income generation, rather than Total Return. It's a fine line, because if one hold companies which continue to generate higher income each year, the value of the company will grow, providing higher Total Return.

The key or at least a danger, is to avoid reaching for Yield in your quest for income. Find the middle ground, above average current yield, with above average dividend growth. It's a slower process and one which can be achieved (at least in my opinion) with a smaller portfolio. I like a maximum of 20 to 25 holdings across all accounts. I also don't feel one needs to hold all sectors, in fact I think many sectors should be avoided, such as All Cyclical companies. I liked to buy the stock which was value priced even if you find your are investing more in one company or sector than the others. The goal was to increase the income, not to rebalance.