Value Line University

Diversification

Smart investors build diversified portfolios.

You create a diversified stock portfolio by buying a variety of stocks in a range of different industries. For most individual investors, a practical approach is to own at least six stocks in approximately equal dollar amounts in six diverse industries.

Diversification is important because portfolios with several different investments usually produce a more consistent and stable total return than portfolios with just one investment. If you own just one stock and it drops dramatically in value, the value of your investment portfolio also drops sharply. But if you own six stocks in different industries, the likelihood is that even if some of them decline in price, others will increase, or, at the very least, remain stable. More than 70 years of investment analysis demonstrates the validity of the diversification approach.

Although your portfolio might not gain as much as if all your money were invested in one stock whose price escalated quickly, it is unlikely to lose as much either. It is important to remember that it is difficult to predict which individual stock will be a winner.

Remember, too, that you ought to think of a diversified stock portfolio as one component of an overall diversified investment strategy which could include bonds, cash, real estate, etc.