Diversifying your portfolio is kind of like blending a variety of coffee beans to create your perfect cup of coffee. Your cup of coffee, just like your portfolio, will be unique to you. While this diversification example sounds simple enough, there are a few pitfalls that apply whether you are investing in stocks, ETFs, or mutual funds.
The reason for diversification: safe investing; to protect yourself and avoid major losses.
You may, for example, want to develop a portfolio based on energy, consumer goods, South America, and health. You may have chosen those areas just because they appeal to you or perhaps you feel more comfortable with them. Different people are driven by a variety of influences, and what’s right for one isn’t necessarily right for another. Just like each person’s cup of coffee is made specific to their tastes.
Some people like Pepsi, and won’t touch a Coke no matter what, and vice versa. Or maybe their favorite-and-only soft drink is Dr. Pepper. I happen to be a Pepsi person myself, but I also enjoy a nice frothy, mellow root beer or cream soda from time to time. The point is that I blend my tastes and stretch my horizons by enjoying more than the one soda that is my personal first choice. This same kind of thinking can be applied to diversifying or blending your portfolio.
A portfolio that is focused strictly on the investments that make you the most comfortable may mean you are missing out on opportunities or suffering unnecessary loses during market declines because you’re limiting your vision of your portfolio. If you blend just a bit, and incorporate some of the other areas into your portfolio, you may actually strengthen your portfolio without having to abandon your preferences completely. If you take your original five areas of investments (energy, consumer goods, South America, and health) and then blend in a few complimentary areas, you create more diversification, more opportunities, and reduce your potential for risk.
In all cases, you are the one that decides the elements that will be part of your blended portfolio.
Consumer goods may include companies that make things but the ultimate buyer is the general public or an actual retailer. In other words, you could include companies in your portfolio that make pills for high blood pressure because their ultimate customers are individuals and you could include retailers who sell snack foods, and yes, you could even include the snack food company. You can do this blending with individual stocks, with ETFs, and with mutual funds that focus on any of the groups that interest you, but by blending some peripheral groups (like Banking, or China) into your portfolio choices, you diversify and give yourself the opportunity to reallocate your money when one part of the economy is surging and other parts of the economy are static or declining. Extensive research or an investment software program that analyzes investments based on some type of relative strength can help steer you toward these opportunities.
As I have said; an important concept to remember when you’re blending your portfolio is that your portfolio represents you. This is a good thing, but it is derived from your basic set of emotions, your likes, and dislikes. If you had a bad encounter with a bank sometime in your past, understandably you many not want banking in your portfolio. While you can’t eliminate emotions completely when it comes to investing, you can control your emotions so that investing goals and investment choices are based on sound analytics. The likelihood that you will succeed increases dramatically when you combine your emotional personality with appropriate analytics when diversifying your portfolio. An investing software program will help you.
The bottom line is, don’t be afraid to look at other segments of the economy or to admit there are parts of it that simply don’t interest you. Remember that moving a little outside your comfort zone, even if it’s just slightly out of your comfort zone, may present you with diversification opportunities that you otherwise may have never considered.
Raymond M.F. Dominick is the author of “Invest Safely and Profitably” (Your Success Guide), available from Amazon.