For numerous reasons, individual investors may find their investment portfolio is focused on just a few particular securities. For some, they may work in industries where stock options are common, such as the Energy, Technology or Consumer sectors. For others, they may get excited about an investment making headlines and be tempted to load up on it.
But remember that “too much of a good thing” may actually be exposing your portfolio to greater risks. Given the volatility and unpredictability of the market, you can’t afford to jeopardize your important financial goals – such as a comfortable retirement or your child’s college education – by putting all your money into just one or two stocks or bonds. Simply put, diversification is key.
Why not diversify?
Despite all the evidence that diversification can help reduce investment risk, many investors choose to put financial resources in just one or a few stocks. Why don’t these investors diversify? Here are some common reasons – and some thoughts on why these reasons may not be valid.
- They’re tied to a company – currently or previously working there. There’s nothing wrong with showing loyalty to a business at which you currently or have worked at. But as an investor, you need to use your head, not your heart. Although the outlook for any company may seem bright at a given time, it’s impossible to predict performance or anticipate changes in a dynamic economy.
- They are happy with the stock’s performance and believe it has great “upside potential.” It’s a good feeling when a stock has been a strong performer, but that does not guarantee future performance. Even when the outlook for a company or industry is favorable, it’s almost impossible to say with any certainty which stock has the most “upside.”
- They don’t want to pay capital gains tax. Taxes are a factor in many investment decisions – but they usually shouldn’t be the driving factor. You may well be better off by selling a stock and using the proceeds to buy other investments than you would by keeping the stock just to avoid paying capital gains taxes. Also, if you’re concerned about taxes, you could spread out your tax liability by selling a certain portion of the stock each month. Be sure to consult with your tax advisor about your situation.
We believe that putting most of your financial resources into just one investment can be risky business. If you’re in this position, ask yourself:
- How would I feel if my $100,000 portfolio declined to $75,000? Or to $50,000? How would that change my ability to meet my goals?
- Are there other investments that might offer similar upside potential, yet help me diversify my portfolio and reduce risk?
Ultimately, diversification doesn’t guarantee a profit or protect against loss, but we believe it can help you weather the market’s ups and downs – and that’s a big advantage for any investor.
Remember the importance of keeping a balanced perspective when you’re tempted to overload on a good investment. Your financial advisor can help you position your portfolio specific to your situation, goals and comfort level with risk.