Friday, October 5, 2007

Portfolio Diversification - Are All Your Eggs in One Basket?

Diversification is a way of looking at your investments and not putting all your eggs into one basket. This is generally done to balance your portfolio, so that when one section is not doing particularly well, your overall balance is maintained by other sections bolstering it. This can further be broken down into the sections of your portfolio, meaning that your stocks are not all in one sector, and bonds are not all a certain grade or from the same industry.

Two points of view on diversification of your portfolio. One is that you should diversify to minimize losses at any given time. This is the better safe than sorry or dont put all your eggs in one basket strategy. Many people are totally sold on this perspective, and I dont think that there is anything wrong with it. A rule of thumb is that the younger you are the higher percentage of your portfolio should be in stocks with a minimum 30% in bonds. This should gradually shift until by retirement you have 30% in stocks.This is to give you peace of mind in retirement, shifting to less risky investments with stable returns in a period of your life when you dont have time to recover from a swing in the market.

The other point of view is to put all your eggs in one basket and keep a very close eye on that basket. This means that if you have extreme confidence in a limited number of investments put most or all of your money in them and keep close track of how they are doing. Fortunes have been made and lost using this method.

I think there are merits to each point of view, and how you invest is a reflection of your personal outlook and where you are at in your life. Are you a risk taker? Are you close to retirement? Are you looking to make great gains, and can afford to take great losses? Risk and return. For the investor, new to the market, diversification makes sense, especially if you are handling your own finances and making your own decisions.

To get to basics diversity means having a variety in your portfolio, not only a mix of stocks and bonds, but also where the companies are located and what they do services, products, commodities, etc.

The question was raised whether having stocks in various companies was enough to protect you from a downturn in the economy, and truthfully there arent a lot of stocks that are going to do that, if you have all your money tied to US companies. So, to start out, you should have some diversification in location. Im not saying buy stock in Arctic and Antarctic companies. However, having some investments in Europe and Asia that compliment your US or North American holdings is a good idea.

A second factor to diversification is to make sure that your investments are also in different industries. For instance, if you invest in a hotel chain, you are putting money into the travel and tourism industry, but the stock price also reflects real estate holdings of the company. That means prices in the real estate market can affect the price of the stock. Also if tourism is down (maybe due to airline issues) the bottom line gets impacted. Those factors aside, you might also want to invest in a manufacturing stock and a mining company. This way your portfolio is multi-dimensional.

So, to take that one step further, if the hotel stock is strictly a US based company, perhaps you might want to look at a steel mill in Europe, and a mining company in Asia. (This is all just for illustration purposes.) These would all be complimented by a few selections of bonds to make up a percentage of your portfolio.

The point being made is having a bunch of different stocks, all in the electronic industry in the United States, is not diversification. Those are all tied together. (in a sense) If you have good timing having a group of stocks in one industry might serve you well. One example would be the dot com craze a few years back. That same example a short while later shows how diversity would have saved you some terrific losses.

I hope this information helped to educate, at least a bit, on the benefits of a mixed portfolio.

Robert Britt is married and a father of four. He is a published author and has a degree in Psychology from Albright College. Robert is a recognized expert in the field of personal finance, self-esteem and confidence building. He is a full time professional writer and speaker. Robert spent 13 years in the military and 14 years in manufacturing prior to self-employment. Please contact Rob at or visit