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Thursday, August 27, 2009

Stocks And Diversification

By Michael Swanson

Probably everyone can identify with the old proverb "don't put all your eggs in one basket". We all know is makes sense not to encourage such risk. The same thoughts can be applied to our investment portfolios - no one likes to think they will lose money. We are told to diversify our risk, but is investor diversification the best plan for everyone?

Where we are at any point in our investment life cycle will have a huge bearing on our tolerance for risk. Some people are naturally risky, others much more cautious. For those starting out in their working careers the money they invest is very limited and they don't want to lose any of it. For those in the wealth accumulation years they tend to be much more risk tolerant. For them there is a bigger base so a small loss isn't as important and they have years to recoup any losses. For those at the end of their working lives or in retirement, the risk profile is probably much lower. All these factors mean that as individuals, our attitude to diversification will be different.

Diversification, by its very nature, means that while our risks are minimized our exposure to profits can also be minimized. The money we have tied up in fixed interest is not available to take advantage of a red hot stock picks or a booming property market.

For the small investor size also matters. He will not have the bottomless investment pool to be able to buy significant quantities of the prescribed, balances share portfolio, plus the property investments plus the fixed income options. Or if he tries he will end up with uneconomically sized parcels.

There are commentators out there who use the examples "Henry Ford didn't diversify, neither did Bill Gates". But in the end these are two successful examples. For all the successes there are countless failures where investors have been wiped out by over reliance in one area.

In the end each small investor has to assess his risk profile and manage his investor diversification appropriately. - 23212

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