The Rookie Retirement Portfolio: Am I Diversified?

|
 |  Includes: BAC, KO, PEP, XOM
by: Parsimony Investment Research

Summary

Retirement "nest eggs" come in all shapes and sizes.

You don't need to be a "pro" or have a $1 million portfolio to get started.

A diversified pool of 5 high quality dividend stocks is enough to get the wheels in motion.

We have written many articles over the past few years about building and maintaining a long-term dividend portfolio. In fact, the reason we started Parsimony Investment Research was to share our research and strategies with fellow Do-It-Yourself investors.

That said, one recurring question that we get from SA readers and premium subscribers is...How much do you need to get started?

It's a great question and one that we are always proud to answer. The beauty of dividend investing is that you can get started by buying just a few stocks, with as little as a few thousand dollars.

Since we've been asked this question so many times, we decided to write a series of articles about building a small diversified dividend portfolio. Below is a schedule of the entire series. Please make sure to "follow" us so that you will be notified when each new article is published.

  • Part 1: Intro / Am I Diversified?
  • Part 2: The 5-Stock Starter Portfolio
  • Part 3: Should I DRIP?
  • Part 4: Adding New Stocks One At A Time
  • Part 5: Breaking the Maximum Diversification Barrier

Am I Diversified?

We've all seen the segment on Jim Cramer's Mad Money where an investor calls in and gives Jim a list of 5 stocks and asks,"Am I diversified?" As cheesy as this segment is...there is legitimacy in the underlying premise.

The basic theory of diversification is that you can reduce non-systematic (company-specific) risk by investing in a variety of stocks. In fact, Nobel Prize-winning economist Harry Markowitz called diversification "the only free lunch".

In theory, the lower the correlation between the stocks, the more risk is reduced. For example, if you owned Coca-Cola (NYSE:KO), you would benefit more by adding a stock like Exxon Mobil (NYSE:XOM) or Bank of America (NYSE:BAC) than you would by adding a competitor like PepsiCo (NYSE:PEP).

The great news for the smaller investor is that the benefits of diversification are exponentially greater for smaller portfolios (i.e., portfolio risk is reduced more by adding stocks 2 and 3 to the portfolio than adding stocks 32 and 33).

With that as a backdrop, below are a few suggested guidelines for building a small, starter portfolio.

Starter Portfolio Guidelines

  • Invest in a minimum of 5 stocks
  • Each stock should be from a different sector group
  • Try to invest equal amounts in each stock so that no stock is more than 25% of total portfolio
  • At least 2 of the 5 stocks should be from "defensive" sectors (e.g., Consumer Staples, Health Care, and Utilities)
  • Limit your high-yield exposure (e.g., MLPs, REITs) to only 1 stock (or 20% of total portfolio).

Summary

A rookie dividend investor can get started investing for retirement by buying just a few stocks, with as little as a few thousand dollars. That said, it's extremely important to stay diversified early on. Part 2 of this series will highlight several good examples of 5-stock starter portfolios to consider.

Disclosure: The author is long KO. The author wrote this article themselves, and it expresses their own opinions. The author is not receiving compensation for it (other than from Seeking Alpha). The author has no business relationship with any company whose stock is mentioned in this article.