Stock Investing Basics: Chapter 7 -- Portfolio Basics

Chapter 7
Portfolio Basics

Remember Axiom #7? The one about putting all of your eggs in one basket? Yeah, that one. If you want to minimize your risk while maximizing your return (optimizing your risk/reward ratio), you'll want to diversify. Diversifying your portfolio takes out a lot of the risk without significantly affecting your reward.

To diversify means to spread your portfolio out into more than one or 5 stocks. 7-10 is a good number. You can certainly over-diversify, too, by investing in too many individual stocks. You also suffer because the more stocks you own, the harder it is to keep track of them and do your homework.

An easy way to diversify is to buy a mutual fund. The fund management team has already done some of the homework and has chosen dozens, if not hundreds, of stocks, taking a lot of the risk out. Don't think that you've diversified simply because you own a mutual fund or two (or ten). Many mutual funds are heavily weighted in one sector or another (or a country). For example, many mutual funds were heavy in technology stocks in 2001, and we all know what happened there!

Such non-diversity really ate into a lot of people's portfolios.

People who run their own businesses could be thought of as ultimately putting all of their investment eggs in one basket. But there is a difference. To say that you've put all of your eggs in one basket is a definite understatement. That business is your livelihood and you really have a vested interest in keeping it afloat and growing.  However, we're talking about investing your extra dollars here, not building a business. So, take it from me: Own at least 7 stocks or a well-diversified set of mutual funds.

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