In order to maximize the prospects of success when building a long term
portfolio Diversification is a virtual necessity. Of course, this topic brings
to mind several clichés that may be a bit hackneyed but are still appropriate.
One is "Don’t Put All You Eggs In One Basket" and the other a
related idea, "Variety Is The Spice Of Life."
The explosive growth of the mutual fund industry in recent years is a direct
reflection of this effort to obtain diversification. Those just starting to
build a portfolio may decide the amount of money they have available for
investment is too small to effectively spread over a number of companies, so
they chose to have a professional manager take responsibility for this in the
form of a pooled fund that spreads the investment over a range of issues.
The benefits of diversification are many. First and foremost is the ability
to spread risk over a variety of issues. If one selected company does not match
expectations and the price of its shares stagnate or decline, one of the other
investments may be having a stellar year and its share value is ascending. By
having spread the investment over two different companies, the portfolio value
Of course, the ideal situation would be to pick only winners and then there
would not be any potential dilution of profit by owning a stock that
under-performs. However, few have been blessed with clairvoyance so the choices
are to risk it all on that "100% sure investment, that will double in
price within six months," or to adopt a dose of reality and hedge one’s
bets by taking into consideration the possibility that there are no guarantees
in life and maybe a bit of caution is in order.
As mentioned, many investors utilize mutual funds for precisely this reason.
With thousands of funds to chose from the investor can select funds that invest
in specific industries, foreign stocks, small cap stocks or large caps or
anywhere it deems attractive. While this has distinct benefits to many
investors, there are drawbacks. The funds may be too large to move quickly to
take advantage of special situations or too many laggards may dilute the effect
of certain successful investments. Additionally, market leadership may change
and the particular fund being used may be falling out of favor. While many fund
managers can accommodate changes into other funds that have different
objectives, this may not always be possible or easily accomplished.
A self-directed portfolio allows the investor direct control over the
decision making process for buying and selling stocks. Portfolio changes can be
quickly accommodated through a reliable broker. However,
the investor must be disciplined to avoid the temptation to put too much of his
assets into high risk investments in the hope of "a quick killing."
Furthermore, to obtain the true benefits of diversification do not just
select several companies in the same industry. Study the prospects for different
industry groups and select some that are contra-cyclical to one another. Namely,
if transportation stocks look attractive it may still be advisable to keep some
money invested in oil company shares since a sudden rise in fuel prices would
likely depress transportation companies, but would be bullish for the oil
It is, however, not necessary or beneficial to select only investments that
are so decidedly opposite since performance of one might negate that of the
other. The idea is achieve balance in the portfolio so that it can grow, or at
least protect the investments, even during changing economic conditions.
In larger portfolios, balance can also extend to investments in certain
industry groups, such as technology companies. While it may not be advisable to
invest only in technology shares, one should consider investments in different
segments of the industry. A computer manufacturer, a chip producer and a
software developer may all be in the same broad category, but could have
significantly different potential.
Many companies now have programs that allow for reinvestment of dividends
into additional shares and small amounts of stock can be bought on a regular
basis by joining various programs, either directly through company sponsored
programs or by setting up monthly investment plans. Another options for small
investors who wish to build a portfolio over time is to join an investment club.
These usually consist of a small group of like-minded individuals who meet
regularly to research possible investments and to pool given amounts on a
There are many ways to achieve diversification. How you get there is less
important than the fact you arrive. Because one should remember, "don’t
count your chickens before they hatch".