Diversification

Diversification improves your performance in the long run and reduces risk all the time.

Diversification includes other asset class besides stocks like oil, gold, cash (yes even cash for better opportunities), real estate... However, stock historically produces the best return.

When an asset is over-valued, it will return to the average historical value with one or two exceptions. Gold is one exception, but it is due to the USD depreciating.

Simply put, owning 10-15 good stocks with less than 2-3 stocks in same sector (which have to be good sectors) achieves diversification goals for most.

However, every one's situation is different:
* Depends on your wealth and your age.
For younger folks with limited wealth (less than $50,000 to invest), a portfolio of 3 stocks (preferably in ETFs) in different sectors could be enough.

For retirees, you may want to have a larger percentage in cash and bond. However, if you're wealthy enough, you can have 100% in stocks as your living standard will not change if you lose 50% of your portfolio. Most rich folks prefer to invest in stocks besides their own businesses as their reward/risk ratios are higher even they are more volatile. Cash is safe but it loses to inflation.

If you have a billion dollars like most mutual funds, owning 10 stocks with 100 millions each is just too risky.

* Excessive frequency in re-balancing your portfolio takes up time from evaluating stocks. It may cost you in transaction fees but they are low in most brokerage accounts today. It may have some tax consequences. The advantage of turning over the portfolio (not excessively) is improving its quality with most updated info.

Your broker statements/summaries may display your current diversification. If not, you need a simple spreadsheet on what sector/asset classes your investments are in.

* Diversification can easily be achieved by buying indexed funds and/or ETFs esp. for smaller accounts and they are less volatile.

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Personal experience.
In 2007-8, I had over 10% return while most other were losing. The reason is my concentration in energy stocks. When oil price dropped from $130 to $32, I lost big. Under diversification caused me false sign of success and led to big loses.


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More readings.
Professor Swensen.

(c) TonyP4 2011. Written in 9/3/11. Updated 9/3/11.

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Disclaimer: All my posts are for informational purposes only. I'm not a professional investment counselor. Seek one before you make any investment decision.