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Showing posts with label Stock Diversification. Show all posts
Showing posts with label Stock Diversification. Show all posts

Monday, May 1, 2017

Why Stock Diversification is Important?

We’ve all heard about the value of diversification in reducing risk in our portfolio, but be sure you understand that there are two types of diversification.

The purpose of diversification is to reduce volatility and improve overall performance. It works if you do diversification correctly.

The first type of diversification is the one most commonly understood as “don’t put all you eggs in one basket.”

This simply means don’t just own one or two stocks. One common way people get in trouble is owning too much of their employer’s stocks.

You may get a good deal on company stock and load up in your retirement fund and buy more for your investment fund because you believe in your company.

It may even seem disloyal not to buy lots of company stock. However, it is not in your best interest if most or your entire portfolio in your company’s stock.

To be truly diversified in your stock selection, you need to own stocks in different industries and in different size companies.

You want your investments spread over large, medium and small companies in a variety of industries. It is especially important to watch the relationship between the stocks so they are not all affected by the same economic factors.

For example, if all of the stocks you owned were extra sensitive to interest rates, then you would not be diversified. The stocks would move in correlation with the interest rates and each other.

Stocks that have a low degree of correlation don’t move as one unit and therefore are less likely to react the same way to bad economic news.

The lesson here for investors is that if a sector of the market is really hot, avoid the temptation to dump “all your eggs into one basket.” However, you should also be aware of those market or economic influences that may adversely affect a group of your stocks.

Don’t put all your eggs in one basket and don’t put all you baskets in the same wagon.

Another type of Diversification:

(Another type of diversification involves the other parts of your portfolio)

If you tie up all of your investments in stocks, no matter how uncorrelated, you are still not diversified in the sense of reducing risk and improving performance.

You need to also spread your investments over different asset classes such as bonds, cash, real estate, precious metals and other alternative investments.

Monday, February 11, 2013

Why Stock Diversification is Important?

Stock Diversification means buying stock in a range of different industries.

On the face of it, diversification ought to be simple: You don't put all your investing eggs in one basket because if you drop it, all the eggs will break!

But it's not that easy. Suppose you don't invest all your available capital in one stock. Suppose you buy two. Are two baskets enough? And which eggs go in which baskets?

No, not so simple indeed. But it's important to figure out because diversification allows investors to reduce risk in their portfolios without giving up any return.

The idea is that, because you cannot possibly know which stocks will perform better or worse than average, you cannot afford to put all your money into one company, or even in companies within a single industry.

You have to spread the risk and the opportunity.

Diversification of investment holdings is the most important shield against risk. Because some investments rise in value while others fall, diversification smoothes out much of the volatility of the overall return from a portfolio. Diversification sacrifices some of the upside potential, but this should be more than offset by the benefits of a lower level of risk.

The trade-off for the balancing of risk and return in a diversified portfolio is that your overall return might be somewhat lower than you could get in an undiversified portfolio. However, along the way, a diversified portfolio will have less volatility, and steadier returns.

The Point is: Don't put all of your eggs in one basket.

Only by diversifying you will be able to realize your average return objective with lower risk. The right level of diversification for you at a given time depends on a variety of factors, including where you are financially, what your goals are, and what the market is doing.

Though literally everyone talks about diversification for their investment portfolio, very few understand the true statistical data underlying the definition. As a result, the majority of portfolios are not properly diversified and an extended risk is being taken, unquestionably unwittingly, but nonetheless evident, by most investors.

In order to cope with the above problem, you have to understand the following:

1. Systematic Risk: This is a risk due to the movement of the market itself. The benchmark could be any Index. If you have one or a few investments in a given area, you could compare its return to that of the benchmark index to determine how well it is doing.

2. Unsystematic Risk: This is the risk of a single company causing a significant move, either up or down. This is usually the risk that most investors would want to eliminate, unless they are "true risk takers!" This risk may be tempered and in fact virtually eliminated, by the purchase of an increased number of stocks.

3. Time Risk: It is usually known that the longer one holds an investment, the less the overall risk. It means that sometimes if you have a risky stock, risk would lower the longer the stock was held.

Proper diversification is the foremost issue in all efficient investments, especially where individual stocks are purchased. It is impossible to properly judge a portfolio if the risk factor is missing. And even if you do understand your holdings, it is mandatory that you must "know your self", and therefore have detailed knowledge of all your investment assets in order to be able to determine the proper diversification and risk.

The importance of Professional Investment Guidance, regardless the performance of the market, cannot be overstated. A qualified financial consultant can assist you with portfolio review and to discuss strategies for achieving your financial goals.

By understanding the basics of investing, working with a professional to design an appropriate portfolio, and allowing your investments time to grow, you can invest successfully.

Saturday, October 16, 2010

Diversify Your Stocks to Avoid Losses

You have probably heard how important it is to diversify your stock holdings – don’t put all your eggs in one basket.

This is a common sense strategy that unfortunately is lost on some investors when they lock on to a hot stock or get involved in a situation where emotions overcome reason.

Many employees holds only the stock of the company in which they are working. There’s nothing wrong with owning stock in the company you work for, however you should be careful that it isn’t the only stock you own.

Diversifying your stock holdings helps you avoid across the board losses if something goes wrong in a particular industry.

For example, if all of your stock holdings were in the homebuilding industry and mortgage interest rates rose to double digits or the housing market crashed (as it did in 2008), it’s likely your holdings would suffer.

You can own different stocks and still not be diversified. Continuing the homebuilding example above, if you held stock in a homebuilder, a financial institution, a major home retailer and a building material supplier you would not be diversified. These holding are said to have a high degree of correlation, meaning each of these companies may be effected by changes in the homebuilding industry.

What you want is a portfolio that is noncorrelated that is the companies are not part of the same industry and not subject to the same economic influences. For example, a homebuilder, an aerospace manufacturer, a paper goods supplier and a computer manufacturer would be a much more diversified portfolio.

Problems that affected one of the sectors would not likely bother the others.

There are other ways to diversify your portfolio: mixing large, mid and small cap stocks; having growth and value investments and including a small percentage of foreign stocks. However, the most important step is to make sure all of your stocks are not subject to the same economic and market influences.

Wednesday, September 8, 2010

Overseas Stock Investment

Warren Buffett once said that diversification is a protection against ignorance. And with the amount of study required, the average lay investor cannot help but be ignorant. So diversification is indeed necessary.

But just how much should one diversify?

Should one go to the extent of diversifying one's stock portfolio with overseas investments?

While overseas investments are a possibility, investing outside India is anything but necessary.

For one, India has an astounding range of companies that one can invest in. The opportunities are plentiful. Add to that the untapped potential that most industries in the country have. And this lends them some amazing growth prospects. With such rich soil in your own backyard, it makes little sense to go around fishing in other unknown backyards (and taking undue country and currency risks).

The only potential advantage one can have by investing in overseas stocks is to have a portion of one's portfolio insulated from a crash specifically in the Indian stock markets. However, for a genuine long term investor, this is not a risk at all. As long he doesn't have to liquidate his holdings during such a bad market phase, such a crash is a non event for him.