Diversify Your Stocks Correctly to Avoid Losses

Diversify Your Stocks Correctly to Avoid Losses

This is a common sense strategy that unfortunately is lost on some investors when they lock on to a hot stock or get involved in a situation where emotions overcome reason.

The biggest danger these days is people loading up their 401(k) retirement plans with company stock. This can happen because many companies offer stock as the “match” part of its contribution to the retirement plan.

Nothing Wrong

There’s nothing wrong with owning stock in the company you work for, however you should be careful that it isn’t the only stock you own.

Diversifying your stock holdings helps you avoid across the board losses if something goes wrong in a particular industry.

For example, if all of your stock holdings were in the homebuilding industry and mortgage interest rates rose to double digits or the housing market crashed (as it did in 2007-08), it’s likely your holdings would suffer.

You can own different stocks and still not be diversified. Continuing the homebuilding example above, if you held stock in a homebuilder, a financial institution, a major home retailer and a building material supplier you would not be diversified.

High Degree

These holding are said to have a high degree of correlation, meaning each of these companies may be affected by changes in the homebuilding industry.

What you want is a portfolio that is non-correlated that is the companies are not part of the same industry and not subject to the same economic influences.

For example, a homebuilder, an aerospace manufacturer, a paper goods supplier and a computer manufacturer would be a much more diversified portfolio.

Problems that affected one of the sectors would not likely bother the others. (By Ken Little)