By Jon L. Ten Haagen, CFP ®
Diversification is not owning a lot of blue chip stocks or mutual funds, nor is it a collection of stocks you have collected over time without a plan.
There are many types and categories of stocks to choose from. Where do you start? Consider how much money you have to allocate to investments. If you have very limited resources you may not be able to create a real diversified portfolio that way. You may have to consider a mutual fund which takes a lot of small amounts from many people and they create a diversified portfolio. These portfolios can be very concentrated in a small area of investment, such as small cap stocks, domestic or international, etc. If you have substantial assets you can create your own diversified portfolio.
My next question for you is how do you decide which stocks to own? Do you have the expertise to make these decisions on your own and do you have the time and desire to take on this task? Before you add an investment to your portfolio be sure it fits with the rest of your portfolio aiming toward your long-term goals.
You have to do your research before you invest. When you look at a stock you may want to look at fundamentals: the company’s earnings and sales history, its level of debt, its management, and its current price and price ratio (compare this to other companies in the same industry).
Another approach is technical analysis which looks at price patterns. With a bond you may look at its rating, its term to maturity and call, and its current yield. With mutual funds, you may be interested in investment objective, manager style, manager’s tenure, long term performance and the fee structure.
You will find that at any time some of your investments will be up and others down. If you want your portfolio to provide the return you need to meet your long-term goals, you have to diversify. Diversification is not a one-time deal. Ask the following questions to measure where you are and what’s your next move: What resources have I committed to buying stocks, bonds, mutual funds, real estate, and other money producing investments? What are these investments worth in relation to each other? Is the portfolio out of balance? How about comparison to a year ago, 5 years ago and ten years ago. How has the portfolio performed based on the indexes, DOW Jones, S&P500, Russell 2000, etc. What investments have I made lately? Are they all basically the same? What am I going to buy next and why?
Over the long haul you may want to revisit and rebalance your portfolio from time to time. You have to think of changes that occur in the securities you own. A mutual fund manager may be replaced and many times the new manger wants to make the portfolio ‘his own’ so there may be a lot of stock changes which could add costs. A strong company may lose its way (Enron, Global Crossing), or an entirely new method for investing may emerge. The bottom line is that you don’t want to assume that diversification is a one-time activity.
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