The Importance of Diversification

The MarketBeaters portfolio can at any time consist of a mix of investments including stocks, mutual funds, ETFs, preferred stock, ADRs, and occasionally bonds. The selection of each portfolio investment is chosen in relation to the current market environment and as identified by the MarketBeaters stock valuation model. In general we try to invest as heavily as possible in individual stocks. Since MarketBeaters follows a long term investment strategy it makes sense to be as heavily invested in the best performing asset class over the long term. Frankly there are rarely enough attractive values in individual stocks to properly diversify however. When this occurs much of the portfolio is made up of low cost index investment to provide adequate diversification and minimize risk.

Diversification is the primary way MarketBeaters minimizes risk. A disciplined approach is followed to not allow the portfolio to become too heavily weighted in one particular holding or industry. Individual stocks are limited to no more than 5% of the total portfolio. A similar limit of 15% exists for any one industry. A significant portion of the portfolio comes from International investments as well.

The past decade has seen two of the worst bear markets in history with a 49% fall in the 2001-2003 technology meltdown and 45% and counting in our current financial crisis. Even with perfect diversification you can see half of your portfolio vanish in a short period of time. Investing in individual stocks just magnifies this. Recently we’ve seen century old financial institutions evaporate in a matter of days with little to no warning. Bear Stearns, Countrywide Financial, Fannie Mae, Freddie Mac, Indy Mac Bank, Lehman Brothers, and Washington Mutual are some of the prominent firms on the list. Shareholders in these companies have been wiped out. The danger associated with having a large portion of your portfolio in any individual stock, regardless of how safe it’s believed to be, is akin to playing Russian Roulette.