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Like most people, you probably gravitate toward things that you’re familiar with and that you like. If you enjoy classical music, your shelves may be full of Beethoven and Ravel. If you love pasta, your cupboards may be bulging with spaghetti and ravioli. In most parts of your life, there’s nothing wrong with this type of devotion — but if it applies to your investment portfolio, you could run into problems.
Specifically, you don’t want to own too many of the same types of stocks or mutual funds — even if you like these investments and are generally pleased with their performance.
What’s wrong with “the more, the merrier” approach to investing? Simply put, it’s too risky. Suppose you owned only stocks of companies that belonged to the same industry, or to a couple of related industries. If a particular set of economic or market forces should hurt these industries, then your stocks would take a hit — and if most of your investment dollars were tied up in these holdings, your overall portfolio could take a hit, too.
You might think you can avoid “over-concentration” by investing in mutual funds. After all, mutual funds may invest in dozens of companies at any time, so aren’t you protected from any industry-specific downturns? It’s not that simple. There are many types of mutual funds available, and some of them concentrate in a particular market segment, such as technology. When something affects these segments, such as the bursting of the technology “bubble” in 2001, these types of mutual funds can be harmed. If you owned just one tech-heavy fund at that time, your overall portfolio probably wasn’t shaken up too much, but if you had several of these funds, you would definitely have felt some pangs of regret when you opened your investment statement.
Keep this in mind: Different investments may respond differently to the same market forces. To give just one example, a steep rise in interest rates may hurt the stocks of financial services companies but have relatively little effect on pharmaceutical stocks. On the other hand, certain legal or regulatory changes can have a big impact on drug company stocks but not cause a stir in the financial services industry. Consequently, if you spread your investment dollars among different types of stocks and mutual funds (as well as bonds, certificates of deposit and government securities), you’ll be less vulnerable to those forces —all beyond your control — that may affect one particular class of assets. (However, diversification by itself does not guarantee a profit or protect against loss.)
Here’s one more reason to expand your investment horizons:
You probably won’t be able to achieve all your financial goals if you own only one type of investment, such as growth stocks or growth-oriented mutual funds. Over time you will have other considerations, such as the need for income, so you’ll need to address this in your portfolio.
These factors also affect the way you approach your 401(k) or other employer-sponsored retirement plan. You may have a dozen or more investment options in your plan, so don’t just stick with one or two of them.
In the investment world, you’ve got many choices — so take advantage of this freedom and flexibility. It may pay off in the long run. |
