Now that you know your comfort with risk, you can begin to build your portfolio.
If you are looking for less risk than the market as a whole, you should be looking at bonds, utility stocks, defensive stocks, and large company stocks. These all tend to have a beta of 1 or less.
If you are looking for more risk than the market as a whole, you should be looking at small cap stocks and tech stocks.
Of course, if you are looking for less risk than the market, you could make the majority of your portfolio low beta stocks and sprinkle in a tech or small cap stock for the greater potential growth. Just make sure you don’t overdo it.
Making Certain You Stay Diversified
While using beta is a great option to building a portfolio, you have to make sure you don’t fall into a classic investing trap. This is when you invest too much in one sector.
For example, let’s say you are looking for a less risky portfolio. You find some good utility stocks to invest in and make up your portfolio of 5 utility stocks. While you succeeded in building a portfolio, you failed at building a diversified portfolio.
By putting all of your money into one sector, you run the risk of losing a lot of money should something happen. For example, let’s say interest rates begin to rise. A common result of this is utility stocks decline in value.
Since you are fully invested in this sector, you are going to lose a lot of money. If you instead owned 1 utility stock and 4 stocks in other industries that aren’t impacted by rising interest rates, you would not experience such losses.
The bottom line is to make sure you are investing in various sectors.
Using beta to build a portfolio is a smart and easy thing to do. All you have to do is make sure you understand your risk tolerance and not build a portfolio that is overweight in one sector of the stock market.
If you can keep these things in mind, you can use beta to help you to easily build a portfolio.
The following article was republished with permission from Modest Money.