For the last two weeks I have been looking at a "new age" diversification strategy, an introduction to the theories in my book. The concept of the theory is to invest 100%, or close to it, in equities, realizing that interest rates are at all-time lows which do not bode well for bonds and that commodity fluctuations are not based on fundamental growth. With equity investments we can buy a part of something that actually builds something else, provides a service, or offers a product that we enjoy. In a flat market an investor can purchase stocks with unrealized value, or that trade illogical, and return gains regardless of market performance. I have succeeded with this practice for the last 15 years, and therefore believe that unconventional diversification practices based on value will protect the investor in any market; preparing for a flat market but ready to capitalize on a bull market.
Today, I am looking at a very specific category, the $100,000 portfolio, which is a huge psychological achievement for retail investors. As someone who first began investing with less than $10,000, I know all too well the trials and tribulations that come with investing, and the psychological challenges that the retail investor encounters as their portfolio both grows and falls. As a portfolio grows, investors have a natural tendency to change their outlook/strategy and over the last two weeks I have covered these changes for the $25,000 and the $50,000 portfolio, and have explained the best investment strategy for retail investors with different levels of worth. In this piece I am looking at the $100,000 portfolio, which is a level that most retail investors seek and use as a significant level of accomplishment, rightfully so; and is also a point in time where risk might want to be drastically lowered.
Diversifying a $100,000 Portfolio
Part of my reasoning for writing this series is to show that there is not a one-size fits all investment strategy, and that strategy should change with wealth. A person with a $25,000 portfolio views his/her investment much differently from a person with a $100,000 portfolio. A person with a $100,000 portfolio is not as willing to take as many risks, although they still want to make money at a fast rate, meaning that "protection" is not the ultimate goal but is still important.
The closet indexing strategy of most fund managers is still not appropriate for most with this sized portfolio. We want large returns, because after all, you can't retire comfortably with just $100,000. Therefore, the strategy that I have laid out takes into consideration the rules in the previous two articles. We are still seeking undervalued high yield stocks, but are increasing our percentage of secular investments for protection.
*Any type of investment such as cash, REITs, ETFs, stocks, etc.
As noted in the previous two articles, secular investments are those that grow or remain consistent regardless of the economy/market. I call these stocks "population investments", companies that grow with the population (this can help determine if a company is secular). Take a look at my selections in the secular category, why I chose each, and why I prefer these over the alternative.
The Clorox Company
Personal & Household
· Target is a diversified retailer that has fundamentally performed well over the last decade. At the surface, the company looks very similar to Wal-Mart (NYSE:WMT), in fact, either would be a great choice. Both return yields around 2.30%, have forward P/E ratios near 12.75, have similar price/sales ratios, have similar cash flow per sales, and have similar debt-to-asset ratios. The difference lies in institutional ownership, with Target having 84% and Wal-Mart just 30%; and also Target having better margins and continuing to improve its margins. Remember, both are good, Wal-Mart performed better during the recession, but Target is quickly becoming a very stable business, having increased its dividend by over 180% compared to Wal-Mart's 100% during the last five years.
· No matter how bad the economy gets, people are going to smoke and drink. Every investor needs a sin stock in their portfolio, and I think Lorillard is best. It has increased its dividend 250% over the last five years, trades below the market's P/E ratio, has institutional ownership of 95%, and trades just 37% as volatile as the market. Combined, there is no better choice.
· McDonald's falls into a category of "recession-proof investments", which I discuss in my book. Stocks such as it are a way to hedge against the market because these stocks typically trade higher in down markets because of consumers seeking cheap meals in a down economy. After a 15 month pullback it has become cheap, has great margins, and has high ownership. McDonald's is the one restaurant stock that will not fade.
· There's nothing exciting about a utility company, but much like McDonald's, they are great hedges in a flat/down market. Over the last decade no utility stock has performed better than ED, and its 4.35% yield, and its beta of 0.18 make it very attractive.
· The Clorox Company was my pick over Procter & Gamble (NYSE:PG) for similar reasons as Target over Wal-Mart. Both are great selections, but The Clorox Company is growing faster (better than GDP), has a lower price/sales, is improving margins at a faster rate, has better ownership, better dividend, and has increased its dividend at a faster rate. With all things considered, I think it's the better choice.
A cyclical investment is one that grows or declines with the market. It is neither short nor long-term, but should be purchased/traded based on price and valuation. If the markets are trading higher and the economy is improving, then so are cyclical investments. These are stocks that typically trade with greater betas and are by nature more risky. Therefore, despite the fact that with a $100,000 portfolio you may want to be safe, you are more-than-likely not satisfied and still want to earn great returns. As a result, here are my selections for this particular portfolio.
· You really can't buy a better stock that General Electric to represent the bulk of the economy. The company is the leader in just about all of its segments, from finance, to aviation, healthcare, lighting, oil & gas, software, etc. Some might say it's a secular investment, and they'd be partially right, but its other segments in finance that make it more cyclical. In a strong economy, the company will boom and will give you a presence in all of the same industries as 3M (NYSE:MMM), United Technologies (NYSE:UTX), and financial companies.
· The auto industry is the strength of our economy, and therefore all serious investors should hold one of the larger auto stocks. Ford is undervalued, pays a strong yield, has good ownership, and now sees a bottom to the European decline.
· Apple now pays a dividend over 2% and is trading at 7x next year's earnings minus cash. The company has a massive ecosystem and rumors of new products on the way. I consider it to be safe at these levels.
· I know there are a lot of people who noticed that I now have two retail stocks, both Target and Best Buy. There are two types of retail: Those like Target and Wal-Mart where consumers shop to obtain there necessities and then others such as Best Buy or Michael Kors (NYSE:KORS), where buying is a luxury. As the economy grows consumers have more money to purchase TVs, tablets, software, etc. Best Buy might finally be a good choice with recent new of regulations on sales tax for online retailers. Best Buy is incredibly cheap with a price/sales of 0.11 and might be a great investment, if it's not acquired.
· Freeport-McMoran is both my play on mining (copper and gold) but also on energy. Remember, the company recently acquired two large energy companies, and since I don't own an Exxon or Chevron, this play is necessary. Not to mention, the stock's cheap and returns a great yield.
Here's the fun part of a portfolio, the portion of a portfolio where your imagination can run wild. This is for speculation, and under this current model it would include two-three stocks. In my book I talk about more complex diversification strategies, many that are determined based on the market (ie recession proof portfolio, strategies to hedge, and different ways to figure risk tolerance and individualized portfolio diversification). However, in this piece, it's a portfolio strategy based on the size of the portfolio, for those who want to still earn money while being somewhat safe.
In this portion you can buy whatever you' like, whether it be biotechnology, small cap, large cap, etc. But for me, in this particular portfolio, I am going to continue with the trend of diversifying based on each stock having a purpose within a portfolio while still trying to include a broad range of industries and sectors, therefore I am adding financial and transportation, specifically American International Group (NYSE:AIG) and XPO Logistics (NYSE:XPO).
In the previous article ($25,000) I covered AIG, showing its level of value and how it has evolved since the recession. The company is presenting great upside, and could return large gains at its current price. XPO Logistics is the largest holding in my (real) portfolio, is a third-party truck brokerage company, and can be explained by clicking here. Both stocks are speculative; neither pays dividends, but could return market leading gains over a course of several years.
This is the third piece in my "Diversifying Your Portfolio" series, and I hope that you are seeing that diversification can be achieved without the use of mindless index investing. In each of my portfolios, regardless of size, I showed you how you can be exposed to multiple industries with fewer investments by purchasing stocks that serve a purpose within your portfolio. This is a complex topic, and this series is barely scratching the surface with a very simple strategy. These are all topics that must be considered when building a portfolio that will perform well and that is built to succeed in a new era of investing. But for now, this is a good place to start, especially if you fall into one of the three categories that we have already discussed.
Disclosure: I am long AAPL, AIG, F, BBY, XPO. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.