–by Jeff Bucher
PUBLICATION DATE: 10.18.16
Ancient Chinese merchants are said to have developed a unique way to reduce their risk. They would divide their shipments among several different vessels. That way, if one ship were to sink or be attacked by pirates, the rest stood a good chance of getting through and the shipment could be saved.
Your investment portfolio may benefit from that same logic.
Diversification is an investment principle designed to manage risk. However, diversification does not guarantee against a loss. The key to diversification is to identify investments that may perform differently under various market conditions.
Some people think that if they own 20 different U.S. stocks that they are diversified. But the reality is that if you have 20 large U.S. companies in your portfolio like McDonald’s, Caterpillar, and Johnson & Johnson you aren’t necessarily diversified. The reality is large U.S. companies tend to move together. When the economy is good, they will be doing well, and if the economy is not doing well, they’re going to be bad. This doesn’t really bring us much diversification so we have to look at different types of investments to bring diversification to the portfolio.
On one level, a diversified portfolio should be diversified between asset classes, such as stocks, bonds, and cash alternatives. On another level, a diversified portfolio also should be diversified within asset classes, such as a diverse basket of stocks.
For example, say a stock portfolio included a computer company, a software developer, and an internet service provider. Although the portfolio has spread its risk among three companies, it may not be considered well diversified since all the firms are connected to the technology industry. A portfolio that includes a computer company, a drug manufacturer and an oil service firm may be considered more diversified.
Similarly, a bond portfolio that invests exclusively in long-term U.S. Treasuries may have limited diversification. A bond fund that invests in short- and long-term U.S. Treasuries as well as a variety of corporate bonds may offer more diversification.
Jeff Bucher is the president and co- founder of Citizen Advisory Group, a comprehensive financial planning company in Perrysburg. Contact him at 419/872-0204; email at firstname.lastname@example.org; visit at 770 Commerce Dr., Perrysburg; or visit the website at www.citizenadvisory.com.
Investment Advisory services are offered through AlphaStar Capital Management, a SEC Registered Investment Advisor. SEC registration does not constitute an endorsement of the firm by the Commission nor does it indicate that the adviser has attained a particular level of skill or ability. AlphaStar Capital Management, LLC and Citizen Advisory Group are independent entities.