Ah yes, we’ve all heard the catchphrases for investing. You know, the ones like “you’ve got to diversify” or “don’t put all your eggs in one basket.” But what does any of this really mean. The fact is a lot of investors get diversification wrong. There’s a lot of bad information out there.
For starters, you don’t need to have 10 major positions to be diversified. If you look at successful funds, you’ll notice that they hold 3-5 major positions. Most of the better ones operate evenly in a few market sectors.
Diversification is not about having more than one stocks. Please understand this. It’s about holding financial positions in more than one sector. Think about it. Let’s say you own 5 tech-based stocks and that industry takes a dive. How is that diversification? You probably lost on all of your stocks.
The key concept behind diversification in stocks is that one sector might be done a little, but another one might be up.
Here’s an important point. If you’re after larger gains, you need to diversify less. If you’re after steady, but lower gains, and less risk, you want to be diversified more. One idea would be to diversify into 3 market sectors for more profit potential, but a little more risk, or into 5 market sectors for less risk and hopefully steady increases.
If you’re comfortable with annual returns of 5-10%, operating in 5 market sectors (or adding a couple more) would be the way to go. If you’re trying to see gains of 15% or greater, you’ll want to limit your positions to 2-3 market sectors.
Another key is to have your market sectors non-linked. If they are linked, then whatever that link is could spell disaster for your entire portfolio.
Closing example. One top fund is operating in these 5 industry sectors evenly: hardware, healthcare, financial services, industrial materials and energy.
For many investors, locating the “good” stocks can be a pain. Here’s a site that lists many best performing stocks. The site updates often and it can give you good ideas for stocks to buy and sectors to invest in. Hope you enjoy the site.
As a side note, you can find a lot of information about funds over at Morningstar. The downside its the site tends to be a bit cluttered. But, many sites use the information from them for mutual funds, etc.