DIVERSIFICATION – investing in different stocks in different sectors – avoids that old danger zone of putting all your eggs in one basket. Loading up on just one stock puts you at great risk. Let’s discuss diversification and three different approaches to diversification for different types of investors.
1. Passive method: Buy market indexes or mutual funds
This approach may work for you if you have very little time to understanding stocks. That’s dangerous. The solution: Buy a low-cost index funds. These are simply funds invested across large collections of companies. Popular indexes include the S&P 500, Dow Jones Industrial Average, and the Nasdaq 100. Investing in an index fund allows you to buy a single ticker symbol that diversifies investments across all of the companies in a given index.
2. Active method: Buy individual stocks
This approach may work for you if:
• You have a deep understanding of stocks, financial statements, and methods for valuing stocks.
• You have time to regularly read quarterly and annual financial statements.
• You are willing to spend five to 10 hours a week analyzing companies.
In other words, you should be willing to comb through financial statements and exercise patience.
3. Balanced method: Buy index funds and some individual stocks
This approach may work for you if you have a basic understanding of stocks and are willing to do limited research to identify good companies to invest in. Another approach to portfolio diversification investors can adhere to is to find a middle ground between making big bets on just a handful of stocks and index fund investing. Warren Buffett strongly encourages the bulk of investors to pursue extreme diversification by investing in index funds. He said that diversification is protection against ignorance.
How Many Stocks Should You Own?
Consider 15 to 20 stocks to go along with index funds. Personally, I own a lot more because I love shopping for undervalued stocks with upsides of more than 15%.
Bottom Line:
There’s no one-size-fits-all approach to portfolio diversification. Deciding how many stocks to own is ultimately a personal decision. A right strategy for one investor could be disastrous for another. Take inventory of your skills, time, and willingness to tolerate volatility and decide what works for you.
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Victor Santos Sy graduated Cum Laude from UE with a BBA and from Indiana State University with an MBA. Vic worked with SyCip, Gorres, Velayo (SGV – Andersen Consulting) and Ernst & Young before establishing Sy Accountancy Corporation in Pasadena, California.
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He has 50 years of experience in defending taxpayers audited by the IRS, FTB, EDD, BOE and other governmental agencies. He is publishing a book on his expertise – “HOW TO AVOID OR SURVIVE IRS AUDITS.” Our readers may inquire about the book or email tax questions at [email protected].