Investors nationwide have been on edge after the worst annual stock market performance in a decade. China trade war tensions, rising interest rates, and the partial government shutdown have caused more volatility. With these recent swings in the stock market, some investors may notice corroborating shifts in their investment portfolio. Even in volatile markets, significant losses in a conservative or moderative portfolio should raise serious concern. Nearly all investors should have a diversified investment portfolio for protection from long-term losses. Diversification is a capital-preserving risk management method that calls for an investment portfolio to carry a variety of investments within different asset classes, countries, sectors, and companies.
Diversification is essential because correlated securities within the same asset class, sector, and country will tend to follow similar patterns. Meanwhile, selecting securities from different areas will reduce such resulting risk. Investment portfolios should not only include investments that differ by asset class. For example, holding many different investments tied to just the real estate sector is not a diversified portfolio. Common sectors include financial, healthcare, energy, energy, utilities, technology, consumer staples, industrials, materials, real estate, telecommunications, and consumer discretionary. Within each of these sectors, there are many excellent choices.
An investment strategy that includes diversification will, on average, yield higher returns and lower risk than a singular holding. A diversified investment portfolio has a cumulative lower variance in return or risk than its lowest asset. In a properly diversified portfolio, the decline of a few of your holdings should be countered by the state of other unaffected holdings. On the other hand, heavy concentration in one investment will leave your portfolio’s increase or decline entirely dependent on fewer factors. For instance, investing all of your money into one stock in a company that goes under will result in the loss of all your money. Ownership of more types of shares over a long time has tended to produce around 5%-8% in returns historically.
Although there is no perfect amount, studies and mathematical models suggested that around 30 stocks should be the targeted amount in a diversified portfolio. Some financial professionals say that a position with a concentration greater than 10% results in greater risk in the financial portfolio and potentially less liquidity. Investors can easily diversify their portfolios by holding the right mutual funds, non-leveraged ETFs and index stocks. The reason is that the funds as mentioned earlier have diverse holdings, depending on the specific selections. The best way to determine if stocks could be regarded as sufficiently distinct for a diversified portfolio, according to some investment advisors, is to find the correlation between their historical returns. A lower correlation between their data would suggest their performance is less likely to be the same at different market points.
Mainly, the average investment portfolio under the watch of a financial advisor should almost certainly be diversified. Otherwise, the financial advisor is not acting in your best interests violating FINRA rules and securities laws. Of course, a very rare highly experienced investor like Warren Buffet (with teams of analysts at his personal disposal) may not need to worry about having a diversified portfolio. However, nearly all other investors should practice diversification, unless they have this level of expertise, time and resources to monitor their investments heavily.
Under no circumstances, should your investment portfolio be anywhere close to 80% concentrated in one stock, let alone equities. If you suffered unjust financial losses that from lack of diversification in your investment portfolio, seek help. Our New York City-based investment fraud lawyers have extensive experience successfully helping investors recover losses resulting from unsuitable investments in a portfolio. Call our securities attorneys today for us to figure out if you have a legitimate claim against the brokerage firm servicing your account.