"Do not put all your eggs in one basket"
Not every stock purchased goes up in value. Even with tremendous amounts
of research, investment professionals are not always right. There are too
many unknowns and too many changes always taking place to be 100 percent sure
that any investment will work out the way you planned. That is one reason why
diversifying your stock portfolio is wise.
How much diversification should you have?
There has been a great deal of emotional and academic debate over how much
diversification is best. The best answer is enough so you have a broad
exposure to the market and not so much that you cannot follow the stocks you
own.
Generally, you should try to have investments in at least 3 or 4 stocks in
at least 4 or 5 industries. A portfolio of 15 technology stocks is not
diversified. A portfolio of one stock in each of 15 different industries
probably also is not a good example of diversification. A portfolio of more
than 25 or 30 stocks can make it difficult to stay aware of what each company
is doing.
Spreading ownership over different stocks in different industries reduces
the risk that the particular stock you choose in a good industry turns out to
be the wrong one. It also reduces the risk that you invested in the wrong
industry.
Diversifying the timing of your purchases
Another way to reduce your risk is to make your investments over a period
of time. That way, you assure yourself that you are not investing all your
money at the top of a bull market cycle. You may miss some appreciation if
the market continually goes up, but that seldom happens. Remember, no one can
predict short-term movements in the stock market with any degree of accuracy.
By spreading your investments over 4 to 6 months, you will eliminate the
risk of making all your purchases when stocks are at their highest points.
There are two types of risk that this strategy reduces. First, it reduces the
risk of losing a significant part of your money quickly. Many people dread
making an investment and then seeing the value go down dramatically. By
spreading out your buying, this will not happen. The other risk you can
reduce by spreading out your investments is price volatility. By taking this
approach, the average price for the stocks you buy will probably reflect the
average market values for that period.
Make diversification your ally
Diversifying the stocks you buy and when you buy them will reduce, but
certainly not eliminate, the risk of making bad investment choices.
Practicing diversification will also enable you to develop discipline in your
investing strategy.
