The best way to diversify your portfolio is to use our Successful Investor approach and branch your holdings out across most if not all five economic sectors

Properly diversifying a portfolio is a good way for investors to cut risk at the same time they maximize portfolio returns. As a key part of their portfolio diversification strategy, most investors should have investments in most, if not all, of the five main economic sectors (more on this below). At the same time, the proper proportions for you depend on your temperament and circumstances.

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Our long-term Successful Investor philosophy puts you in a better position for lower-risk profits and includes advice on the best way to diversify your portfolio

We continue to recommend that you invest in well-established, high-quality dividend-paying stocks, like those we recommend in our newsletters, including our flagship publication, The Successful Investor.

When the market is unsettled and volatile, you need to resist any urge you may feel to buy or sell on impulse. Instead, keep the mechanics of successful investing in mind. Here’s a brief explanation of our three-part Successful Investor approach to portfolio building:

1. Invest mainly in well-established, dividend-paying companies. Ideally, some of your picks should have hidden assets. That is, assets that many investors disregard or fail to appreciate.
2. Again, it’s important to spread your money out across most if not all of the five main economic sectors: Manufacturing & Industry, Resources & Commodities, Consumer, Finance and Utilities.
3. Downplay or avoid stocks in the broker/media limelight, where even a modest business setback can set off a deep, sudden and sometimes permanent drop in the stock.

Our second rule tells you how to diversify effectively, rather than simply buying a variety of stocks. This has two benefits. It keeps you from investing too heavily in any industry or sector that is headed into a period of big losses. This cuts your risk of losses. But, by spreading your investments out more widely, you also improve your chances of latching on to a market superstar—a stock that will wind up producing two or five or 10 times more profit than average. Over the course of any investing career, you need a few super stocks in your portfolio, to offset the losses you’ll have from the inevitable duds.

The best way to diversify your portfolio: A brief look at the five main economic sectors

1. Manufacturing & Industry: A company in the Manufacturing and Industry sector is subject to the ups and downs of the economic cycle. They can expose you to above-average volatility.

Manufacturing stocks may suffer if raw-material prices rise, but in that case, your Resources stocks will gain. Rising wages can put pressure on manufacturers, but your Consumer stocks should do better as workers have more to spend.

2. Resources & Commodities: Resource stocks produce and sell a range of commodities. These include oil, copper, nickel, uranium and aluminum, as well as fertilizers. It’s hard for resource producers to bring a distinct product to market, but they can distinguish themselves by how efficiently and profitably they find and produce their commodities.

The resource sector is subject to wide and unpredictable swings in the prices that firms get for their products. In the rising phase of the business cycle, when business is booming, resource demand expands faster than resource supply, so resource prices shoot up. This balloons profits at resource companies. When the economy slumps, resource prices fall, and this drags down resource profits and stock prices.

In addition to rising and falling with the business cycle, however, resource stocks have a history of rising along with long-term inflationary trends. This gives them a rare ability: they can provide a hedge against inflation.

3. Consumer sector: Consumer firms benefit from continuous and often habitual use of their products and services, so they have much more stability in their sales and earnings, regardless of the state of the economy.

Companies like Proctor & Gamble, Kraft Heinz Co. and the spice company McCormick and Co. are all in the Consumer sector.

Consumer-sector stocks are apt to fall in the middle, between the more-volatile resources and manufacturing companies and the more-stable finance and utilities companies. Consumer spending is a key part of the Canadian and U.S. economies, accounting for roughly two-thirds of activity.

4. Finance: Profits of Canadian Finance and Utilities firms tend to be more stable than profits of Resources or Manufacturing companies. Stocks in the Canadian Finance and Utilities sectors typically entail below-average volatility.

Canadian banks are an example of Financial sector stocks we recommend. That’s because these stocks generally pay high, secure dividends, and have long histories of raising their payments, even during downturns.

5. Utilities: Utility stocks include companies that provide electric power, telecommunications and pipeline services. As part of the Successful Investor approach, we continue to recommend that income-seeking investors buy high-quality utility stocks instead of bonds. Their yields are competitive with bonds—and Canadian dividends are tax-advantaged over interest.

And while most utility stocks are steady income producers, the best utility stocks also offer opportunities for growth.

What have you found as the best way to diversify your portfolio?

Do you have a well-diversified portfolio, or have you opted to focus on a particular sector?