Written by Jonathan Perrin
Volunteer Director of Financial Education, More Than Baseball
One of the most important investment concepts that lead to investment success is diversification. Diversification is an investment strategy that simply put, follows the old adage that “you should never put all your eggs in one basket.” Diversification is used to manage the inherent risk of an investment portfolio; it reduces the impact of any one investment’s performance on your overall wealth. Rather than concentrating money in a single investment. Think of it like this: your portfolio is like a baseball batting lineup. You have multiple players, and not every single one is going to be an all-star every year. You build your lineup based on each individual player’s strengths and weaknesses. Different players are going to get hot at different times in the season, and for different lengths of time. The key is to just keep playing your players (investments) every day to let their cumulative stats (returns/profits) pile up over time.
Any single investment should not make up 10% of your total investment portfolio if you are investing in individual companies. My general rule of thumb is that you should never let any one position grow to the point where it is more than 25% of your net worth. So if you buy something (say Bitcoin or Amazon stock) and it has a monster rally like we have seen in recent years, once you start pushing up against that 25% threshold you should strongly consider trimming that position back down closer to the 10% level and reinvest the proceeds into other companies.
The exception to the 10% rule is if you are using diversified ETF’s or Mutual Funds. For example you can get exposure to the entire S&P 500 – and index that consists of the 500 largest, profitable, and publicly traded companies in the United States; under one ticker symbol (IVV or SPY). For even broader diversification that goes across the entire US stock market you can use a total stock market fund like the Vanguard Total Stock Market Index Fund (VTI). For the most bang for your buck, you can even get exposure to the entire global market through funds such as the Vanguard Total World Stock ETF (VT). Index funds like this can give you broad diversification in simple, cheap, and effective wrapper. Typically for younger, growth minded investors we recommend to clients a combination of stocks and index funds for diversified long-term growth.
If you have questions about how to build a portfolio, or would like a free second look at your current holdings. Please reach out! https://scnv.io/0Op5