The Motley Fool

What is Diversification?

moneyI am sure you have heard of the phrase: “Many hands make light work”. Well in investing, putting different types of shares into your portfolio can help to reduce stock market risk.

The rationale is that different companies tend to behave differently at different stages of an economic cycle. So, if you have a portfolio of different shares, it should help to smooth out the peaks and troughs as different types of shares fall in and out of favour at different times.

The key is to ensure that the portfolio is made up of shares from different industries. So simply buying shares in ten different banks is not diversifying. That’s just putting all your eggs into the banking basket, and we all know what can happen if banks take a fall. Nor would packing a portfolio full of agricultural companies or utilities be diversifying.

Typically, a diversified portfolio should have shares in about 15 to 20 companies from different sectors. You may even want to think about shares from different parts of the world too. However, be careful not to over diversify your portfolio too much. While many hands might make light work, too many cooks could also spoil the broth because you are in danger of turning your carefully chosen portfolio of shares into an index tracker.

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The information provided is for general information purposes only and is not intended to be personalised investment or financial advice. Motley Fool Singapore Director David Kuo doesn’t own shares in any companies mentioned.