Why have a portfolio?
What you'll learn:
- Why you need to diversify
Having a portfolio lowers your risk of losing money. That’s because, no matter how hard you try, some of your investments won’t turn out the way you expect—they will lose you money. But this is nothing to be ashamed of—even very experienced investors make poor investments on occasion. But by having a basket of shares for example, a 35% fall in the price of one particular stock will have a much less significant effect on your overall portfolio.
A portfolio also reduces the inevitable fluctuations in value that occur between different investments. Some investments take time to mature, while others perform well at different stages of the economic cycle. Your eventual aim should be to have different classes of investments, such as a spread of shares, fixed interest and property (see Why Invest). Having a portfolio helps ensure that if your property investments perform poorly in any given year, a good performance from your shares might offset it (property and share markets tend to have different economic cycles).
Maintaining a spread of different investments is called diversification. You may know it more simply as ‘not placing all your eggs in one basket’. But how does this apply to your share portfolio?
Well, within the shares asset class, you should also aim to have sufficient diversification. This means you should hold a portfolio of shares in a number of different companies. That way, good performances from those that do well will offset any that perform poorly. This helps ensure the return on your overall share portfolio is less volatile than it might otherwise be.
- Wikipedia is a good source for all sorts of information. Click here to read its explanation of diversification. It also provides links to other information such as dollar cost averaging and portfolio theory.
- The Intelligent Investor often discusses the issue of diversification. Click here to read one of its Investor’s College articles on the topic.