Ways to diversify your investment portfolio abound. Philosophies and recommendations appear monthly if not daily and weekly in the media.
Diversification could easily be the subject of a book, much less a basic article. There are many ways to diversify your portfolio but first you must understand that the basic reason is to protect your investments.
The first step is to decide how many investment accounts you want.
Most people trade in either their regular account to grow their wealth and cash, or in a retirement account. Personally I would like to suggest you ultimately consider three or four accounts:
Retirement – to take care of your later years with tax free income.
Wealth – to build your wealth and give you more spending cash or for special objectives like a new home or a trip to Italy.
Emergency – to build an emergency fund for the unexpected like when you suddenly need knee replacement surgery or your “paid for” car hits a deer and is totaled and you want to buy a new one with cash.
I know it is difficult enough to manage one account, and for most of us to even come up with the cash to start just one is a challenge. But the benefits of having these three or four different investment accounts is nothing short of spectacular.
When we purchased our home the bank wanted to see us plunk down some of our own money. That’s not unusual as a 20% down payment is pretty common. But I also wanted to get our new place off on the right foot, not improve it as the years sailed by, but pretty much right off the bat. That meant the dreamed about hot tub underneath the canopy of an all cedar gazebo and a few rows (yes rows not just a few) of upright juniper trees would also add another ten grand or so to the new home bill. I was able to use our personal wealth account without touching the retirement or emergency accounts, keeping those intact.
If you need to start one account at a time, start with the retirement account, then the emergency and finally the wealth and special desire accounts.
Limit your investments in each account. I vividly recall an army captain tell me that squads and the chain of command in the military was usually based on eight. A sergeant could effectively command eight soldiers, a lieutenant no more than eight sergeants or sergeants and corporals, etc. William J. O’Neil writes in his books about keeping your portfolio to around eight stocks. When you start out you may only be able to have two positions, but as time grows you can diversify into more, remembering that about eight positions in a portfolio makes the portfolio easier to manage and thus easier to be successful.
To achieve this aspect of eight positions in a portfolio just divide your total portfolio value by eight and try to keep the positions balanced when you sell and buy.