By KIRK G. AGUER
Diversification is an investment strategy that helps you avoid putting all your eggs in one basket. When you allocate your investment dollars among many investments, you potentially reduce the risk of a single investment and help to optimize your overall return given your risk tolerance. There are a number of ways you can diversify when deciding which stocks are best suited for you.
Diversify among industry sectors. A sector is an area of the economy comprised of industries that have certain characteristics in common. All industries in a given sector typically tend to react similarly to trends in the overall economy. In general, you should include stocks from a number of sectors, but dedicate a greater dollar amount to the sectors that are currently in favor.
Diversify by risk level. There are many categories of stocks with different degrees of volatility. A well-diversified portfolio may include stocks from a number of risk levels, since lower-risk stocks are likely to offer greater portfolio stability and higher-risk stocks tend to provide higher potential rewards. As you near retirement age, you may wish to adjust your portfolio to reduce risk. Of course, your risk tolerance will vary with your individual situation.
Diversify globally. Foreign stock markets provide an extra degree of diversification, which has been shown to reduce portfolio volatility and enhance returns over time. Keep in mind that past performance does not guarantee future results, and overseas investments are subject to certain risks beyond those applying to domestic investments, such as political, market, economic and currency exchange risks.
In the end, the specific way you choose to diversify your portfolio will depend upon your individual investment objectives and risk tolerance. Your Financial Advisor can help you determine which methods are best for your own individual financial situation. (Kirk Aguer is a financial advisor at MorganStanley’s Santa Monica branch. He (310) 319- 5220.)
Originally published in the Santa Monica Daily Press print edition on March 16, 2006. Read the original PDF.