- 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).
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.