Diversify Your Investment

An investor who places all his funds in a single stock is naturally more at risk than one who spreads his investment cash between several stocks. As the old saying goes, all ones eggs should not be placed in a single basket.

Company fortunes fluctuate, not only with the economy, but also with performance of management and sales staff, reception of new products, and with the outlook for the business sector in which the company operates. There will always be companies that are ahead of the competition, and those that lag. An investor who puts all his money in a single stock is more likely to suffer a loss than one who has invested across several stocks, because the fortunes of a single company can change dramatically. Those that held shares in companies such as Enron and WorldCom understand this: one day the companies were worth billions of dollars, the next they were worthless.

An investor may concentrate on a single sector: perhaps he is an expert in the oil industry and has close relationships with management of several companies, for example. Such an investor will be blessed with the knowledge that means his investments can be concentrated within the energy sector, though by spreading his investment across several companies his risk will be lessened.

For most investors, however, diversification is best made not simply by investment in several stocks in a single sector, but rather by investing across several business sectors. Industries and services grow at different paces according to wider economic issues. Sudden shocks to the system can throw stock valuations into free-fall. By investing across several sectors, and then in several stocks within those sectors, an investor protects his portfolio from such economic and company specific shocks: winners make up for losers.

A useful by-product for the stock market investor who takes the time to diversify his investments across different business sectors is the growing ability to select the best sectors at any point in an economic cycle, and the better stocks within those sectors.

Portfolio diversification has the natural effect of not only spreading and lessening risk, but also of increasing the chances of investment in the best performing stocks. It also means an investor will have continued exposure to a business sector that sees high growth but concentration of business. Perhaps one of the best examples of this is the automobile industry. In the 1930’s there were hundreds of companies manufacturing vehicles in America. Today there are only a handful of these remaining, and yet the industry is one of the largest in the United States.

The bottom line for the investor is that diversification is a key component of a successful stock market portfolio. For those that don’t have the time or inclination, or perhaps the investment cash available, to usefully diversify, then similar can be achieved by investing in a diversified mutual fund.