The rules of diversification
Financial experts will tell you to diversify your investments and you should – Here are some ways to go about diversifying your investments:
First of all, when many people think of diversification they think of putting money in many, many different stocks. In reality, you don’t need more than eight to ten stocks in order to be diversified. Personally, I typically only hold eights stocks at any given time. This number allows you to reap the rewards of good stock picks while also protecting your portfolio against one-time disasters.
The second thing to remember is to diversify across industries. Typically, when a portfolio performs poorly it is not because of an event tied to the particular stock per-se, but rather poor conditions in the stock’s industry. By diversifying across multiple industries, you are able to spread this risk since different industries do well at different times during the economic cycle. This results in smoother portfolio performance and less risk of loss.
Finally, the reason that most financial advisers bring up diversification to begin with is because people tend to overweight their 401k’s with company stock. Now, if your company has matching contribution to your 401k for company stock, this is definitely something you want to do - since it is essentially an immediate XX% gain! However, you should move that money eventually into other stocks. Diversification requires that you not only hold eight to ten different stocks, but also that you have them equally weighted.
