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Like most people, you probably gravitate
toward things that you’re familiar with
and that you like. If you enjoy
classical music, your shelves may be
full of Beethoven and Ravel. If you love
pasta, your cupboards may be bulging
with spaghetti and ravioli. In most
parts of your life, there’s nothing
wrong with this type of devotion — but,
if it’s carried over to your investment
portfolio, you could run into problems.
Specifically, you don’t want
to own too many of the same types of
stocks or mutual funds — even if you
like these investments and are generally
pleased with their performance.
What’s wrong with “the more,
the merrier” approach to investing?
Simply put, it’s too risky. Suppose you
own a bunch of stocks of companies that
belong to the same industry, or to just
a couple of related industries. If a
particular set of economic or market
forces hurt these industries, then your
stocks are going to take a hit — and if
most of your investment dollars are tied
up in these holdings, your overall
portfolio will take a hit, too.
You might think that you can
avoid this problem of
“over-concentration” by investing in
mutual funds. After all, mutual funds
may invest in dozens of different
companies at any time, so you’re
protected from any industry-specific
downturns, aren’t you? Actually, it’s
not quite that simple. There are many
different types of mutual funds
available on the market, and some of
them do concentrate in a particular
market segment, such as technology. And
when something happens that affects
these segments, such as the bursting of
the technology “bubble” in 2001, these
types of mutual funds will be negatively
affected. If, in 2001, you owned just
one technology-heavy fund, your overall
portfolio probably wasn’t shaken up too
much, but if you had several of these
funds, you would definitely have felt
some pangs of regret when you opened
your investment statement.
Keep this in mind: Different
investments may respond differently to
the same market forces. To give just one
example, a steep rise in interest rates
may hurt the stocks of financial
services companies, but have relatively
little effect on pharmaceutical stocks.
On the other hand, certain legal or
regulatory changes can have a big impact
on drug company stocks, but not cause a
stir in the financial services industry.
Consequently, if you spread your
investment dollars among different types
of stocks and mutual funds (as well as
bonds, certificates of deposit and
government securities), you’ll be less
vulnerable to those forces — all beyond
your control — that may affect one
particular class of assets.
Diversification does not guarantee a
profit nor does it protect against loss.
And here’s one more reason
to expand your investment horizons: You
probably won’t be able to achieve all
your financial goals if you only own one
type of investment, such as growth
stocks or growth-oriented mutual funds.
Over time, you will have other
considerations, such as the need for
income, so you’ll need to address this
in your portfolio.
These factors also affect
the way you approach your 401(k) or
other employer-sponsored retirement
plan. You may have a dozen or more
investment options in your plan, so
don’t just stick with one or two of
them.
In the investment world,
you’ve got many choices — so take
advantage of this freedom and
flexibility. It can potentially pay off
in the long run. |
