In order to achieve a high return by investing in the stock market it is generally the case that one has to accept more risk. To minimise the risk, most private investors allow their money to be run by an investment manager where it will represent a tiny percentage of a large portfolio that will be spread across many different stocks, sectors and perhaps even different assets and markets. The downside is that this approach limits the return as most fund managers achieve a return that lags the market index and there are also high charges that erode returns.

For private investors who choose to manage their own portfolio the limited number of stocks makes it more difficult to spread risk without making the individual size of holdings so small the effect on performance is minimal.

Certainly, if you really believe in company’s prospects and the quality of its management a large holding is appropriate so that you materially benefit from the upside. The following is a suggested strategy for allowing large holdings within the portfolio while still limiting risk.

The broad sector approach

In an earlier post I suggested a barbell approach as a way of benefiting from both capital growth and income. By adopting this strategy a portfolio will naturally limit risk as the stocks at opposite ends of the barbell will usually perform well at different times. However, this can be taken further by looking at what areas of the market your portfolio is exposed to. Broadly, there are 5 categories of stocks in the UK market and these can be summarised as:

Commodities: these are represented by the natural resource shares, oils and mining. For the UK they are a disproportionately large part of the market even though the big companies have little to do with the UK economy. One of the reasons the market did well last year was the recovery in commodity prices which contributed to earnings upgrades and strong share price performance. This trend has continued in 2017 but most of the easy money has been made.

Financials: the banks, insurance companies etc. This is a large sector (dominated by HSBC, the second largest stock in the UK) but not as big as it used to be partly because of the financial crisis but also due to many takeovers and mergers that has contributed to consolidation within the financial…

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