Improving Investor Savvy Part IV: Diversification

By: La’ Nise Harrington Spring 2017 Student Intern

Previously, in the fourth part of this Improving Investor Savvy series, we discussed knowing the basics of investing. It was not intended to be an exhaustive list, but one important basic was not mentioned: Diversification. Diversification is a portfolio strategy that many employ in order to mitigate potential losses. Imagine investing all of your money into the stocks of Company X. Unfortunately, the X market experiences a horrible year and now your whole investment is worth 5% of what you originally invested. It’s a devastating loss.

Unfortunately, while no one wants to think about loss, everyone should plan for it and diversification is one way. Therefore, the fourth question from FINRA’s July 2015 National Financial Capability Study in this five-part series is obvious:

Do I understand portfolio diversification?

Diversification in a portfolio can simply be described as variety. However, according to FINRA’s National Financial Capability Study it seems that many investors do not understand this concept in practice, especially those who invest less than $50,000. These investors are more likely to own only individual stocks rather than a mixture of mutual funds, stocks, REITs, annuities and other investment vehicles. You might be thinking “while yes I only have stocks, but they are in a wide array of industries.” If this was your thought your concept of diversification is not complete. It is important to diverse not only the types of investment vehicles you have, but the types of industries that each investment vehicle is based on. If your development of diversification needs help FINRA has provided an excellent general diversification overview that is available here.