Diversification of investment holdings is the most important shield against risk. Because some investments rise in value while others fall, diversification smooths out much of the volatility of the overall return from a portfolio. Diversification sacrifices some of the upside potential, but this should be more than offset by the benefits of a lower level of risk.
The point is this: Don’t put all of your eggs in one basket. Although the attractiveness of stocks over the long term is stressed in this publication, all investment capital should not go into this class of assets. In addition, you should diversify your holdings even within each class of assets. For instance, a list of at least 20 stocks, spread across different industries, can provide adequate diversification for an equity portfolio. To diversify a fixed-income portfolio, securities should be held with different risk levels and different dates of maturity.
However, investors should also be wary of having too many different investments, or over-diversifying. There may come a point when a new investment largely mirrors an investment that is already held and does little, if anything, to lessen the risk or increase the return of the overall portfolio. In addition, keep in mind what level of costs (e.g., fees) are associated with making a new investment, and whether you or a good investment advisor will have the resources to keep appropriate records and adequately monitor the new investment being considered.
This includes continually reviewing whether the investment remains attractive and keeping good records related to its cost and performance. The process of investing is not over after the purchase has been made; the value and appropriateness of the asset should continue to be evaluated while you own it, and a time may come when there are good reasons to sell it. For small and large investors, placing some money in funds can offer relief from the task of selecting individual securities.
By Kwaku Fredua-Agyeman