Spreading your portfolio’s risk is key to sound investing. Learn how to diversify and reduce your overall risk.
Diversification to reduce risk should seem obvious to most investors but a surprising number of people follow their instinct rather than intellect when it comes to investing. Diversification is a simple concept: If you are shoe seller then you want to sell sandals and snowshoes to take advantage of sales in any season rather than putting all of your eggs in one basket. The same goes for stocks: diversification to reduce risk is easy once you conceptually understand that a limited amount of money is chasing the entire basket of available goods or services.
Diversification takes many forms: market capitalization, domestic vs. international, industry focus, etc. Also, asset allocation is a concept that involves several security types: stocks, bonds, cash. So, that’s not applicable.
A solid diversification strategy is to invest in a diverse basket of stocks by focusing on various industry sectors, like: banking, consumer staples, technology, natural resources, health care, etc. If you buy 1 or 2 stocks in each industry, you’ll manage risk better than buying stocks all from one industry or one country.