Diversification
A diversified stock portfolio consists of a wide variety of investments. Diversification is one of the best ways to reduce risk, as a diversified portfolio will ensure that the performance and fluctuation of a single stock will have less of an impact on your entire portfolio.
So what are some ways to diversify your stock portfolio?
The first way is to invest in stocks that have different risk levels. For example, you could invest in a combination of large cap stocks, mid cap stocks, and small cap stocks. Large cap stocks are generally less risky than small and mid cap stocks, as large caps usually are stable companies that have been around for a long time. Small and mid cap stocks are more risky than large caps, as they are smaller and/or newer companies that are still relatively unstable. An example of a large cap stock is McDonald’s (MCD), while an example of a small cap stock is WuXi PharmaTech (WX).
The second way to diversify your portfolio is to own stocks in many different industries. By investing in companies in different sectors, you will minimize losses if one industry absolutely tanks. For example, if your portfolio consisted solely of technology stocks in 2001, you would lose a ton of money when the tech bubble burst and many tech companies went bankrupt. But, if you owned a tech stock, along with stocks in other sectors, then your losses would be minimized and would not destroy your entire portfolio.
Because you should own shares in companies in multiple sectors and with various risk levels, it follows that you need to own more than one company in your portfolio. I actually think that the ideal number of companies to own in a portfolio is between 5 and 10. Less than 5 companies will not allow you to be diversified enough, and more than 10 makes you too diversified. So, learn to spread your risk and you will keep yourself from losing everything. If you pick solid stocks and stay diversified, the profits will surely follow.
Niki Pezeshki
College Trillionaire
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This is great to know, but in those 10 choices, do we use mostly the same industry or diversify that too?
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