Buying One Stock vs. Diversifying Your Portfolio
You often hear this catchphrase when receiving investment advice: "Don't put your eggs in one basket. You must diversify." Nearly every investment adviser has used that phrase at one time or another. It is a philosophical approach to investing that has earned popularity through sheer repetition, and still holds true today as one of the basic unwritten rules to sound financial planning.
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The One-Stock Approach
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The benefit of the one-stock approach is simplicity above all, as keeping track of your investments is as easy as looking up one stock price every once in a while. If you choose a solid, reputable company, with a long established track record, you feel confident that the stock price will continue to rise in the long-term. You then will have achieved the same goal that money experts say only can be achieved through diversification, without the trouble of keeping track of a number of different statements from a variety of investments.
Risks
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The main underlying risk of the one-stock approach is the fact that you have no safety net if that investment runs into trouble. You might think you are holding the stock of the one company that will never let you down, but there is a reason people say "Never say never." Bear Stearns and BP at some time might have looked like surefire bets, but if these had been your only holding, you would be hard-pressed to recover your losses in a timely fashion. If a company declares bankruptcy, you might never recover those losses.
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Diversification Explained
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Diversifying your investments means to spread the risk around, not only by company but by industry. If you hold 25 banking stocks, you might not be diversified because you are exposing 100 percent of your portfolio to financial industry risk. A well diversified portfolio should contain at least a dozen stocks spread around a variety of industries such as natural resources, finance, retail and manufacturing.
Asset Class Diversification
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Another way to diversify is by asset class, meaning to allocate some investments into different classes such as treasury bills, bonds and certificates of deposit. When stocks take a tumble, those investments can provide a cushion against a major financial hit, as well as provide a measure of stability to your portfolio.
Consider Mutual Funds
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A good way for the average investor to diversify and have his money professionally managed is through mutual funds. There are countless funds from which to choose, each offering to pinpoint different segments of the market with varying levels of risk/reward scenarios. Mutual funds also allow you to diversify globally with access to the markets of other countries, one more diversification method which provides safety when the U.S. economy is unstable.
Conclusion
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Even though it is entirely possible that owning just one stock over most of your lifetime can achieve the long-term goal of growing your investment portfolio, the diversification approach can lead to the same result while at the same time greatly reducing your exposure to market risks.
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References
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