How you diversify your investment portfolio should relate to the amount of time you can spend managing your investments.
If you have very little time or just want to spend a few hours (or less) a month managing your portfolio than you will want to look at mutual funds, stocks that will be for the long term or ETFs for the long term.
If you are willing to trade more frequently, or even very frequently, then you can use different criteria in picking your investments.
Most mutual funds have restrictions on how frequently you can trade without paying a penalty. Some funds require that you hold them 30, 60 or even 90 days. Such holds automatically reduce your trading activity. Many fund families also have what is called round-trip penalties. These penalties literally stop you from making any type of trade for a year if you violate the fund’s rules which typically say you can’t sell and buy back any combination of the same funds four times in a year.
The drawback to investing solely in mutual funds is that you may be at greater risk of losing your money during a major or long-term drop in the markets like our recent recession. This is precisely why during this recession you heard about so many people losing more than 50% in the value of their retirement account.
The alternative to mutual funds is exchange traded funds, simply known as ETFs. These are similar to mutual fund groups but not managed on a day to day sell/buy basis like mutual funds. Since they trade like stocks they can be bought and sold at any time. Many of the popular brokerages now offer many ETFs with no trading fees, but even then trading fees have become almost negligible.
You can also find individual stocks for the long haul, particularly dividend paying stocks.
So once you have decided how much time you can devote to managing your investment portfolio you can select the groups you want to work with (see our article, “Your Diversification Questions”)
There is software on the market that you can load onto your computer that will let you analyze stocks, ETFs or mutual funds in a manner that matches both your tolerance for risk or potential losses and the amount of time you have for management. For example, by telling a software program like Dynamic Investor Pro that you prefer to hold your positions a minimum of 30 days you will limit your trading frequency dramatically compared to someone who says their preferred holding period is just five days.
There are other means of controlling your trading frequency to match your available time. There are also other aspects of controlling the diversification of your investment portfolio that we will discuss in the future.