Years ago, a world-class software designer for the investment industry said something I will never forget:
"Diversity makes America great."
My friend, an Iranian immigrant with a deep appreciation for the strength and resilience of the U.S. economy, made the comment in reference to the the many different nations represented on his programming team.
Our nation blends the best attributes of many cultures, socio-economic groups, educational backgrounds and attitudes. This mélange is a key reason for our continued economic success on a national and an international level.
However, on an individual level, I’d like to add on to what my friend said and impart my own words of wisdom to you:
"Diversity makes investing in America great."
Diversity is important for your investment portfolio, too. By bringing down artificial barriers, you can capture each component’s best attributes.
I follow five diversity rules closely in my own trading that I’d like to share with you today. I’m confident they will help you, too.
Have you heard? Sunlight & Water Could Make You Rich in America These Days (Shocking)
If you live in America, please pay attention.
If you grab a bottle of water and leave it in the sun, nothing much will happen, right?
Well get this — these two components, sun and water, could make you rich.
Well, not if sunlight and water is now used to create a new type of natural gas.
And some insiders are getting ready to plow their early investments into sunlight and water … and ride it out to absurd profits ahead of everyone else. You need to see this for yourself >>
RULE 1: DIVERSIFY BY SECTOR
"I have a diversified portfolio of five computer software stocks," someone told me in early 2000. Later that year the dot-com bubble collapsed. With his tech portfolio demolished, he stopped boasting about his investment prowess.
The lesson: While it’s OK to have favorites (I love tech, too!), look at different sectors and spread your commitments around several of them.
RULE 2: DIVERSIFY BY COMPANY SIZE
If a company with 95% market share in its business improves to 96%, the relative benefit is negligible.
Now imagine if that same percentage point of market share went to a smaller player. A company that goes from 1% market share to 2% effectively doubles its business. You will see the difference. This is why small-cap stocks can often show faster growth.
Not 10 years ago, Apple (AAPL) only had 1% of the PC market share; today it sells more than 10% of the world’s computers.
However, we have to define "small" correctly. My favorite measure is to look at a company’s revenue relative to its peers. Total market capitalization is the next best definition.
Small isn’t always an advantage. Consider the same scenario but assume each company loses a percentage point of market share. The larger one is much more likely to survive.
Solution: Have a well-diversified portfolio including both large and small companies.
RULE 3: DIVERSIFY GEOGRAPHICALLY
In today’s globalized economy, the location of a company’s headquarters may not tell you much. Many U.S.-domiciled companies do more business overseas than at home. Likewise, many foreign companies have a big U.S. presence.
Nevertheless, a diversified portfolio should include exposure to different regions and countries. Here are some questions I ask in determining my own portfolio weightings.
- Do I have a combination of large and small countries?
- Are most of my holdings in democracies?
- Are the nations committed to free trade?
- Are the countries relatively free of corruption?
RULE 4: DIVERSIFY TO CONTROL PORTFOLIO RISK
A pension fund, whose time horizon spans decades, may accept severe volatility in exchange for higher growth prospects. The situation is different if you count on your investments for a new home, college costs, retirement or living expenses.
Diversification helps reduce overall portfolio volatility — if you do it right. Growth stocks tend to be the most volatile while large, dividend-paying stocks usually fluctuate less.
Carefully and deliberately combining the right investments will give you a "head start" toward my last diversity rule, which is …
RULE 5: DIVERSIFY TO BALANCE ‘GROWTH VS. VALUE’
If you already diversified your portfolio under my first four rules, this last one may take care of itself. Nevertheless, look at every potential investment and determine its primary purpose.
If you acquire it with price appreciation in mind, it goes in the "growth" category. If your main goal is to generate current income (such as dividends) with price stability, you can call it a "value" investment.
Growth and Value often overlap each other. A dividend-paying stock can give you capital gains, too. That’s why I said to consider your primary purpose.
7 More Tips to Attract
A Wider Array of Returns
Here are some other tools to help achieve portfolio diversification:
- Thoroughly research each holding to determine if its price, as well as its potential upside and downside, is appropriate for you.
- Look at a security’s price history. Does it make wide swings in a short amount of time? This kind of volatility is great for shorter-term holdings, but if you’re in it for the longer term, you may want to avoid names that make heart-stopping drops on a regular basis.
- Set a minimum and maximum number of holdings.
- Establish limits for any single security, sector and geographic region.
- Identify your current income requirements and make sure your portfolio can provide it.
- Have a cash reserve for emergencies or planned expenses.
- Look for investments with low correlation. In other words, if one of your positions zigs while another zags, a portfolio containing both will be less volatile.
In addition, I like to set lower and upper time constraints for portfolio moves. Consider also whether to plunge in with a "lump sum" or take more measured moves. In either case, it is always important to plan your portfolio changes.
The guidelines I described today help me achieve diversity for Global Trend Trader readers. I’m confident they will help you, too.
Good luck and happy trading!
P.S. Not long ago, one of my colleagues was "attacked" in Australia.
Strangely, he’s thrilled that it happened. In fact, he says that single moment led him to one of the greatest potential home-runs of his career. Get all the details here >>