3 Must-Have Assets for Any Winning Portfolio

Source: Thinkstock

Source: Thinkstock

One of the most important facets of portfolio construction is diversification. You need to have several kinds of assets in your portfolio because if one asset class loses a substantial amount of value, you will be protected from significant losses.

However, diversification goes beyond just holding stocks in different sectors. In what follows, I provide investors with three kinds of assets that they need to include in their portfolios in order to be properly diversified. While their function in a portfolio is specific, these recommendations are general enough so that as an individual investor you can customize them to suit your personal risk tolerance and your own outlook on the economy.

1. Foreign Assets

Many investors in the U.S. are U.S.-centric in their investing. We have better access to knowledge about U.S. companies as Americans, and we don’t have access to many foreign investments. However, there are a lot of excellent foreign investments. Many foreign stock markets are substantially cheaper than the S&P 500, and many of them also pay higher dividends. Furthermore, there are economies out there that have significant potential. For instance, many emerging economies have young, growing populations that are becoming more affluent and more productive as they get older.

Fortunately, we live in the age of ETFs and ADRs (American depository receipts), and these make it very easy to get access to funds holding several foreign stocks as well as individual foreign stocks. Investors have several options for gaining international stock exposure. For instance, a simple way to do so without taking on individual stock or country risk is to buy an ETF such as the Vanguard Total International Stock ETF (NASDAQ:VXUS). This fund is comprised of shares of the major companies traded throughout the world.

More aggressive investors –or those who have the time to investigate the benefits and detriments of investing in specific economies — have access to various individual country ETFs. For instance, one of the best performing stock markets this year is the Turkish Stock Market. Investors sold off Turkish shares last year in the wake of social unrest, and that created a great buying opportunity to invest in one of the world’s fastest growing economies at just 12 times earnings. Investors who are interested in Turkish stocks can conveniently buy the iShares Turkish ETF (NYSEARCA:TUR).

Source: Thinkstock

Source: Thinkstock

2. Income-Generating Assets

You need to have an investment that pays a substantial dividend. Income stocks will protect you in a down market, especially since the best dividend paying stocks are more defensive than your typical non-dividend paying stocks.

Finding a good high dividend paying stock is a little tricky in this low interest rate market environment. While there is no shortage of options, many companies pay high dividends because investors are concerned that they will not be able to sustain the dividend. Therefore, a good strategy is to look for companies that have stable businesses that are distributing a large portion of their profits to shareholders. The downside is that these profits cannot go into growing the business, but you can invest in growth companies with some of your other assets.

There are several good places to look for high dividend paying stocks. For instance, one option is the tobacco industry. These companies don’t have rapid growth, and it doesn’t have many outlets for investing their profits, and so it pays outsized dividends that exceed 5 percent. Other options include telecommunications companies such as AT&T (NYSE:T) and Verizon (NYSE:VZ), which have steady income streams and pay dividends that are substantially larger than your typical S&P 500 company. More aggressive investors can look into smaller, higher dividend paying companies such as the prison owners and operators – Corrections Corp. of America (NYSE:CXW) and the Geo Group (NYSE:GEO), which pay 6.3 percent and 6.9 percent dividends, respectively.

Source: Thinkstock

Source: Thinkstock

3. Gold

Every investor needs to own some gold. Gold has been societies choice of a long term store of value for millennia, and a 2-year bear market hardly changes this fact. Gold is very inexpensive compared to where it has traded historically in the past. Furthermore, many central banks and investors all over the world — especially in China, Russia, and India — are accumulating gold. There is rising demand and a smaller supply resulting from lower production. While gold has been in a bear market for some time, it has made a strong double bottom at about $1,200/ounce, and yet over the course of the 21st century, it has significantly outperformed stocks.

Investors who are looking to own gold have several options. The easiest way is through an ETF. While many investors like the SPDR Gold Trust (NYSEARCA:GLD), I prefer the Sprott Physical Gold Trust (NYSEARCA:PHYS), which has better tax treatment if you plan on holding it for more than a year. More aggressive investors should consider mining companies, although keep in mind that gold mines don’t necessarily make more money because the gold price is rising — production costs can rise as well. A better alternative is the gold royalty companies, which buy the right to receive a set amount of gold at a fixed price from a mining company. Royal Gold (NASDAQ:RGLD) and Franco Nevada (NYSE:FNV) are the two largest royalty companies, and both have significantly outperformed the gold miners, the price of gold, and the S&P 500 over the years.

Disclosure: Ben Kramer-Miller is long Royal Gold shares.

More From Wall St. Cheat Sheet: