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Why a Diversified Portfolio is Absolutely Essential

“Don’t put all of your eggs into one basket.” That’s the gist of a diversified portfolio. It means that, when the certain stocks or industries take a hit, your portfolio remains robust and unfettered. To achieve long-term financial success in investing, you must have a portfolio that can withstand the shocks of a volatile market. Having a truly diversified portfolio is key.

How do automakers survive when a model turns out to be a dud? They have other models in their line-up. How do television networks survive when a hit show turns out to be a flop? They have other shows in their line-up. We see this principle play out in just about everything in life. You don’t eat only one kind of food because, if that food ceases to be available, you don’t want to starve.

“Diversifying our portfolios” in all other aspects of life is clearly the dominant strategy. Why do so many neglect the concept when it comes to investing? Some people pick “favorite stocks.” They like the company–maybe the management team or the brand–and they make financial decisions based on their personal affinity toward it. Bad idea. It isn’t a badge of honor to “sell-out” and give your entire portfolio over to a single company. Your goal isn’t to support any one company; your goal is to provide a more secure financial future for yourself.

Having a lot of companies in your portfolio, though, doesn’t necessarily make it diversified. Consider a portfolio with the following stocks:

  • IBM
  • Dell
  • Hewlett-Packard
  • Motorola
  • Xerox
  • Microsoft
  • Novell
  • Sun Microsystems
  • Intel
  • Texas Instruments

I could keep adding to the list, but I think you get the point. All of these companies are in the computer technology industry. They all either make hardware or software for computers. What happens if that industry experiences a decline? There goes your portfolio! It isn’t enough to put all of your eggs into different baskets if you’re going to put all of those baskets into one larger basket.

The key problem that investors face is a lack of information from “investment professionals.” Most portfolios are packaged and promoted in a way that makes them look diversified. But, when it’s all said and done, the selected mutual funds are the same with different names. Savvy investors will ask financial advisors to prove that investments really are diversified…and respectable financial advisors will offer proof before they are even asked.

So how many stocks make a portfolio diversified? Some pundits would have you believe that a diversified portfolio consists of roughly a dozen stocks. That could not be further from the truth. You want to have thousands in your portfolio. Investment strategist Mark Matson recommends having a portfolio of 12,000 individual stocks in 45 different countries from around the world.

Don’t get fooled by “experts” pitching big-name stocks composing a portfolio with little diversity. Contact us to find out how we use academic techniques to create a truly diversified portfolio for our coaching clients. We take diversification very seriously.

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