Every Wednesday, we publish our “Investor Toolkit” series on TSI Network. Whether you’re a new or experienced investor, these weekly updates are designed to give you specific advice on a wide range of investing topics. Each Investor Toolkit update gives you a fundamental tip and shows you how you can put it into practice right away.

Tip of the week: “When you focus on investment quality and favour growth stocks over momentum stocks, you multiply your chances of success with aggressive stocks.”

Most investors understand the chances you take with aggressive stocks. Along with the potential to produce higher returns than more conservative stocks, they bring the risk of bigger losses. And they are often more highly leveraged and volatile than conservative stocks.

But that doesn’t mean you should avoid aggressive stocks altogether. Even for conservative investors, there are very good reasons to turn to aggressive stocks. There are ways to earn big returns without exposing yourself to excessive risk. Below we explain four principles that we use to select growth stocks for Stock Pickers Digest, our newsletter for the aggressive part of investors’ portfolios.

And keep in mind that we focus on growth stocks, which have a good long-term history and favourable prospects. We downplay momentum stocks, which attract many investors simply because they are moving faster than the market average, but are liable to fall sharply when their momentum fades.

1. Limit aggressive holdings to 30% of your overall portfolio. Because aggressive stocks expose you to a greater risk of loss, we recommend limiting your aggressive holdings to no more than about 30% of your overall portfolio.

That number can vary. Ultimately, the percentage of your portfolio that you should hold in either conservative or aggressive investments depends on your personal circumstances and risk tolerance. An investor with a longer time horizon or without the need for current income from a portfolio can invest more money in aggressive stocks. But we think 30% is a good rule of thumb.

2. Focus on investment quality when looking for aggressive stocks with the potential for higher returns. When we look for aggressive investments, we zero in on companies that have established a business and have at least some history of building revenue and cash flow. We also look for companies that stand to benefit as the economy continues to improve, and have proven management and long-term growth plans.

That’s very different from so so-called concept stocks, many of which are start-ups or companies that look to profit from next week’s or next year’s investor fad. These companies can generate big returns in a good year. In the long run, though, they are likely to cost you money.

Avoid overhyped stocks that may be in for a brutal downturn

3. Diversify your aggressive investments: As with your more conservative holdings, we recommend that you cut your risk by spreading your aggressive holdings across the five main economic sectors (Manufacturing & Industry; Resources; Consumer; Finance; and Utilities). Your emphasis may diverge. In the search for greater gains, you may choose to invest more heavily in Manufacturing and Resources, the two riskiest sectors. If so, take care to spread your money out across the many industries within each of these sectors. That way, you protect yourself from an unforeseeable industry downturn.
4. Downplay stocks in the broker/media limelight: That limelight fosters bloated investor expectations. Stocks that are talked up like this may seem like ideal candidates for big gains, with lots of investors getting on board. But when stocks fail to live up to those expectations, brutal downturns follow.

Applying that aspect of our conservative philosophy to an aggressive portfolio leads us to stay out of most new issues. That’s because most new issues come to market when it’s a good time for the company or insiders to sell. That’s rarely a good time for you to buy.

Tomorrow in Best U.S. Stocks we report on the big acquisition that has boosted the maker of Chef Boyardee and Peter Pan peanut butter.