Portfolio Diversification Is the Simplest Way to Lower Risk. Here's How I Build Mine.

I prioritize buying companies with a history of increasing dividends and high yields that are above average. Finding clusters of such stocks in certain sectors is important for me. I aim to own around 34 investments in total. While the Fool suggests owning 50 stocks, that number is quite large and time-consuming. Owning 50 stocks from just one sector does not truly diversify a portfolio. A well-diversified portfolio should consist of a reasonable number of investments across various sectors and asset classes.

I begin by evaluating my investment goals and capabilities. My goal is to achieve a balance between income and capital appreciation, and I am confident in my ability to select dividend stocks. However, I also understand that I cannot manage too many stocks simultaneously. Therefore, I work with various pooled investments to diversify my portfolio effectively.

For example, I own two Baron mutual funds to gain exposure to growth stocks and smaller companies. I also own several closed-end funds, each focused on specific areas like healthcare stocks with an income overlay, convertible securities, and a broadly diversified dividend portfolio. Additionally, I own three exchange-traded funds that pick dividend stocks using different screening approaches.

This diversified foundation of pooled investments allows me to invest in individual stocks with more confidence, knowing I have a strong base to work from. I prefer to buy companies with a strong history of increasing dividends and high yields that are historically high. After careful research, I only purchase stocks that I believe are worth owning.

My current portfolio includes a mix of real estate investment trusts, consumer staples companies, energy stocks, and utilities. These are areas where income opportunities are often found, so I try to allocate my investments accordingly while maintaining a broad sector spread.

When I buy a stock, I allocate a specific dollar amount to establish a position size. Once I reach that full position size, I do not add more to it. While this approach may limit potential upside, it also helps limit potential downside risk. I aim to buy stocks with historically high yields, even if the underlying business might not be performing well at the moment.

For example, PepsiCo, despite being a successful company with a long track record of dividend increases, is currently underperforming in my view. I believe the company will bounce back, so I see it as an opportunity to buy with a high yield. Warren Buffett's strategy of buying undervalued stocks with strong dividends aligns with my approach, so I am comfortable with this strategy.

I also keep cash on hand as a safe-haven investment, as it provides flexibility in both good and bad markets, though it may not keep pace with inflation over time.