This is the second of an 8-part series on building a successful investing strategy.
The second key practice in building a successful investing strategy is to make sure that your portfolio is well-diversified.
A properly-diversified portfolio will increase you returns and reduce the risk of your portfolio.
One part of diversification is to own a large number of equities (stocks). But, good diversification means more than just that.
A well-diversified portfolio will also be diversified in terms of:
- the size of the companies in the portfolio (your portfolio should contain the right mix of large, mid-sized and small company stocks)
- US vs international (your portfolio should include the proper mix of equities from the US, established international counties and emerging markets)
- Sectors (your portfolio should contain equities from all market sectors)
- Value vs. Growth stocks (your portfolio should contain some of each)
- Equity vs. Real Estate (your portfolio should contain some of each)
The best way to achieve diversification in your portfolio is to use mutual funds. When you buy a mutual fund you obtain instant ownership in hundreds of individual stocks or bonds. The use of mutual funds gives you broader access to the equity market at a lower cost than you could achieve by investing in individual stocks. A mutual fund allows for diversification between many different stocks and also allows for diversification between various sectors, styles, etc. This diversification allows you to reduce the risk of one particular stock or sector, but also allows for more potential reward by offering a broader exposure to various stocks and sectors.
Future articles will address specifically how to select which mutual funds will be the best for your portfolio and how to design a portfolio with the proper diversification along all of the criteria mentioned above.