Diversification, it is a term we often hear thrown about to explain how one can properly protect their investments. How many times have you heard someone say “I don’t want to keep too many eggs in one basket”? What they are talking about is being diversified. Many people feel if they invest their money with different investment companies or own different mutual funds they are diversifying their investments, but is this a true assumption? Most likely it is not.
The real key to being diversified is to own investments in not just different companies but different types of companies. Not just owning different assets but owning different types of assets like equities and fixed income. In this article we will focus on how to be diversified in equities.
The world economy is made up of many different sectors, industries, and businesses. Owning investments across that landscape is how one can achieve good diversification. If different people or fund managers invest your money, how do you know they are not buying the same assets for you? If you cannot see the name of the company you are buying then how do you really know what you own?
Diversification starts with breaking down the overall economy. Economists break it up into different sectors like healthcare, technology, finance and so on. Within a sector like healthcare there are different industries like drug makers, drug distributors, medical device makers, or even healthcare providers like hospitals or nursing facilities. To own companies in these different areas of the economy is how one can help diversify their investments. Not all of the sectors or industries within these sectors do well or do poorly at the same time. So the concept of having your eggs in different baskets for protection is beginning to be put into practice. Putting a small portion of your money into these different types of companies is how one can truly achieve diversity within the stock market. It is how you invest, not how many people invest your money for you that will diversify your assets.
It is this type of diversification within the equity markets that we put into practice for our clients’ here at B&C Financial. Our investment model contains between fifty and sixty different types of companies at any given time. By owning such a diverse group of companies one can enhance the protection they have in their investible, equity assets.
In the meantime while one is monitoring their diversification they are also monitoring their asset allocation as we discussed in The Importance of Asset Allocation. As we mentioned earlier in this article, in addition to owning different types of companies you also would be better diversified by owning different asset types. Fixed income has historically been a counter balance to stocks. In the future we will discuss how to properly invest in fixed income in order to achieve a diversified portfolio.