Using Portfolio Diversification

Portfolio diversification means having several non-correlated investments within the same portfolio, and even within an asset class, and is used as part of a stock trading or investing risk management plan.

For people who are Day Trading or Scalping, this type of risk management may not come into play as much, if at all, on a small scale.

On a larger scale though, most investors and traders may find themselves better off to be using some type of portfolio diversification.

Even a Scalper who is only looking for quick profits, should only be using part of the total funds he/she has available, thus having the remaining funds in a non-correlated investment. Even if that means sitting in cash.

Note that there are successful traders who are "active traders" who restrict the number of open positions to as few as one at a time who do well over the long term, but, I have found this very hard to do for most people.

Let's go over a few things that I'd like to point out from my experience on this topic:

  • Using Mutual Funds as a way to diversify:
    Many years ago, I remember having my investment funds in a few Mutual Funds. For years they did very well. Then, 1999 and 2000 came along.

    During these years they lost just about everything they had gained over many years prior. Looking back now, I had thought that Mutual Funds were a safer way to go due to the fact that each of the funds held many different stocks in them.

    What I found out quickly was that during a stock market crash, having mutual funds with many stocks in them still go down large percentages no matter how diversified they are. The only difference is that some go down more than others. What I personally feel I missed out on is learning about rebalancing a portfolio periodically to try and help minimize long term losses.
  • Depending on a persons age, a different mix of stocks, CD's, cash, money market accounts and bonds may be looked into. This relates to asset allocation and diversification (and rebalancing) should occur within each asset class. See next:
  • Within each of the above different area's, diversification should occur also. Such as not having all of your cash in one bank; having several CD's; having holdings in stocks that are varied such as in different area's like healthcare, technology, U.S. stocks, foreign stocks, bonds, etc.
  • Not having all of your cash in one bank also means to remember not to have all of your investments in one brokerage firm as well. Think Bernie Madoff.

Basically, what I have seen work well is to remember not to have all of your eggs in one basket. We've all heard this before but many people forget to follow this.

A person that had a diversified long term investment portfolio over the last several years has typically done much better than maybe someone who had a large percentage of their holdings in financial or real estate related investments.

If using individual stocks for your portfolio, diversifying with maybe 15-20 stocks or so might be something to consider. This would allow you to spread out your investments into different area's while having a manageable portfolio as compared to having 40 or 50 stocks. This of course depends on the individual.

Each person may have different methods that work for them and as I am not a financial advisor nor did I start Online Stock Trading Guide to write much about longer term investing risk management strategies, remember to check with your own advisor before making any financial decisions. The information I have provided here is to get you thinking about NOT having all of your investment portfolio funds in one area, just in case.

On the opposite end of the spectrum of course is the person who puts all of his eggs in one basket and strikes it rich. There are people who have seem crazy returns like 1000% or so, but the chances of that happening are similar to playing the lottery I think.




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