Stock investors constantly hear about the wisdom of diversification. This simply means don't put all your eggs in one basket. Diversification helps reduce risk and generally leads to a better return on investment.

That said, there are many ways to diversify. How you choose to do it is up to you. Your goals for the future, your appetite for risk, and your personality are all factors.

Key Takeaways

  • An aggressive portfolio takes on great risks in search of great returns.
  • A defensive portfolio focuses on consumer staples that are impervious to downturns.
  • An income portfolio concentrates on shareholder distributions.
  • The speculative portfolio is not for the faint-hearted.
  • The hybrid portfolio diversifies across asset classes.

The following are five broad types of investment portfolio, with some tips on how to get started with each of them. One of them, or a combination of more than one, is sure to meet your needs.

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5 Popular Portfolio Types

The Aggressive Portfolio

An aggressive portfolio seeks outsized gains and accepts the outsized risks that go with them.

Stocks for this kind of portfolio typically have a high beta, or sensitivity to the overall market. High beta stocks experience greater fluctuations in price than the overall market. If a stock has a beta of 2.0, it will typically move twice as much as the overall market in either direction.

Aggressive investors seek out companies that are in the early stages of their growth and have a unique value proposition. Most of them are not yet common household names.

Look for Fast Growth

Look for companies that have rapidly accelerating earnings growth but have not yet been discovered by the average investor. They are most often found in the technology sector, but they can be found in other industries as well.

Risk management is critical when building and maintaining an aggressive portfolio. Keeping losses to a minimum and taking profit are keys to success in this type of investing.

The Defensive Portfolio

Defensive stocks do not usually carry a high beta. They are relatively isolated from broad market movements.

Unlike cyclical stocks, which are sensitive to the underlying economic business cycle, defensive stocks do well in bad times as well as good times. No matter how rotten the economy is generally, companies that make products that are essential to everyday life will survive.

Look for Consumer Staples

Think of the essentials in your everyday life and find the companies that make these consumer staple products.

As a bonus, many of these companies offer a dividend as well, which helps minimize capital losses. A defensive portfolio is a prudent choice for most investors.

The Income Portfolio

An income portfolio focuses on investments that make money from dividends or other types of distributions to stakeholders.

Some of the stocks in the income portfolio could also fit in the defensive portfolio, but here they are selected primarily for their high yields.

An income portfolio should generate positive cash flow. Real estate investment trusts (REITs) and master limited partnerships (MLP) are examples of income-producing investments. These companies return much of their profits to shareholders in exchange for favorable tax status. REITs, in particular, are a way to invest in real estate without the hassles of owning real property.

Keep in mind, however, that these stocks are also subject to the economic climate. REITs take a beating during an economic downturn, when new construction and purchases dry up.

Look for High Dividends

Investors should be on the lookout for stocks that have fallen out of favor but have maintained a high dividend policy. These are the companies that can supplement income and provide capital gains. Utilities and other slow-growth industries are an ideal place to start your search.

An income portfolio can be a nice complement to an investor's paycheck or retirement income.

The Speculative Portfolio

Among these choices, the speculative portfolio is closest to gambling. It entails taking more risk than any of the others discussed here.

Speculative plays could include initial public offerings (IPOs) or stocks that are rumored to be takeover targets. Technology or health care firms in the process of developing a single breakthrough product would fall into this category. A young oil company about to release its initial production results would be a speculative play.

Financial advisors generally recommend that no more than 10% of a person's assets be used to fund a speculative portfolio.

Leveraged ETFs

The popularity of leveraged exchange-traded funds (ETFs) in today's markets could arguably represent speculation. They are investments that are alluring because picking the right one could lead to huge profits in a short amount of time.

The speculative portfolio is the one choice that requires the most research if it is to be done successfully. It also takes a lot of work. Speculative stocks are typically trades, not your classic buy-and-hold investment.

The Hybrid Portfolio

Building a hybrid portfolio requires venturing into other investments such as bonds, commodities, real estate, and even art. There is a great deal of flexibility in the hybrid portfolio approach.

Mix It Up

Traditionally, this type of portfolio would include a core of blue-chip stocks and some high-grade government or corporate bonds. REITs and MLPs may also make up a portion of the assets.

A hybrid portfolio would mix stocks and bonds in relatively fixed proportions. This approach offers diversification across multiple asset classes. That in itself is beneficial because equities and fixed income securities tend to have a negative correlation with one another.

The Bottom Line

At the end of the day, investors should consider all of these portfolios and decide on the right one or, even better, the right combination of more than one.

Building an investment portfolio requires more effort than the passive, index investing approach. If you go it alone, you'll have to monitor your portfolio and rebalance it more frequently. Too much or too little exposure to any portfolio type introduces additional risks.

Despite the extra required effort, defining and building a portfolio can increase your investing confidence and give you control over your finances.