I’ve been struggling with diversification this week.

The SIF portfolio is now reasonably diversified, but is running short of cash. There’s not really any compelling reason to add more stocks without selling some first. But there are a few companies in my screen results I could add if I wanted to.

The problem is that a rules-based portfolio isn’t about doing what you want. The selection of stocks is meant to follow a process. So what do my rules say about this situation?

When I originally launched the SIF portfolio in April 2016, I laid out the following guidelines for diversification:

The target size for the portfolio will be 15-20 stocks.

Macro-economic diversification will be managed by maintaining an approximate 50/50 split between defensive and cyclical stocks. Beneath this, I will try to ensure that at least four of the ten main stock sectors are represented.

Here’s how I’ve managed against these three criteria:

Portfolio size: Reinvesting profits and extending my holding period from six to nine months means that the portfolio currently has 22 holdings. There’s only enough virtual cash to add one more stock.

Cyclical versus defensives: I’ve discussed the portfolio’s shortage of defensive stocks many times. The market continues to price most defensives too richly for my screening criteria. At the moment, only about 15% of the SIF is in defensive stocks.

Sector diversification: The portfolio contains companies from seven of the ten main stock sectors, so this requirement is satisfied.

The challenge facing me now is to decide how to proceed from here.

I may need a new rule

My first choice would be to add another defensive stock. But there aren’t any new defensive stocks in the screen results at the moment, so this isn’t possible.

Another possibility would be to add a stock from one of the missing sectors (Energy, Healthcare and Telecoms). But none of these qualify for my screen at the moment, so this isn’t possible either.

This leaves three possible options:

  1. Add new stocks to sectors where the portfolio is underweight, in order to try and achieve even sector weightings.

  2. Ignore sector weighting and focus on adding the companies with the highest StockRanks.

  3. Don’t buy any new stocks at all. The portfolio is already over its target size. I can save the limited cash for the next defensive opportunity.

My original rules don’t really…

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