The value of diversification as a risk management tool can often get lost in good times. When bull markets rage on, and investors see their portfolios grow every month, the temptation to load up on one specific stock or a group of stocks or let such stocks become a very large percentage of one’s portfolio can take hold.
Having too many eggs in one basket or even a few baskets (even if these baskets are of the highest quality) can be dangerous if market conditions change drastically.
Assessing the percentages each stock makes up in a given portfolio from time to time is a great strategy all investors should employ, whether quarterly, semi-annually or even annually. Making sure one is not too heavily invested in one specific company or sector can reduce concentration risk and portfolio risk and help avoid steep short-term declines in one’s portfolio value in a bear market.
Being defensive is not always a glamorous strategy. This does carry some downside in times like these, when momentum takes some overvalued stocks into the stratosphere. But over the long term, diversification has been proven to be one of the most effective and simple ways investors can reduce risks over long periods of time.
Differing views on the number of stocks one ought to own exist. However, the vast majority of the benefit one receives from diversification exists with owning 10-30 stocks. Buying an Exchange Traded Fund (ETF) is another excellent way to gain high levels of diversification in a low cost manner, particularly for passive investors.
Invest wisely, my friends.
