Diversification is often used to smooth the return on investments. Typically, investors do not buy just one kind of stock even if it is Facebook publicly traded company.
On the contrary, most traders choose a perfectly balanced mix of assets which is called portfolio. A stock guru could include not only stocks, but also bonds, mutual funds and foreign exchange.
Investopedia discusses how each diversification strategy can resolve specific source of risk. First of all, consider bonds and stocks moving in different directions so holding both types will better protect your investments.
In the current turmoil bonds pay virtually nothing so one may just go with cash or a checking account. Another alternative is emerging markets that lost 30 to 50 per cent of its value.
If money does not seem to be a constraint then now is the best time to buy property in Greece and Spain that were hit badly by the crisis. Villas on the Mediterranean initially purchased by Lehman Brothers bankers are now available even for middle income customers.
The second important strategy is to select securities with differing volatility and return level. Blue chips are typically overrated so you cannot make a lot but less known stocks may offer high returns for many years to folllow. Stability in blue chips could be further enhanced with potentially high benefits of smaller corporations.
Finally, do not invest all you money into a single industry. This became especially clear after the dotcom bubble of the 90s and a recent Facebook IPO date. Buy companies producing real stuff such as Camson bio stock.
Nevertheless, even perfect diversification of the portfolio does not guarantee against market and currency risks. Greenbacks remain the perfectly liquid asset that bears no other risks except for inflation. Although cash is subject to inflation other securities can devalue after inflation as well.
What is the minimum acceptable number of stocks in a perfectly diversified portfolio? Experts define 20-30 stocks as the optimal portfolio size.
However, this is number may be prohibitively high for an assistant professor of economics with a few thousand dollars. First, many IT stocks similar to Apple may cost well in excess of a few hundred dollars. Second, for each transaction you will have to pay broker a few dollars.
Thus, this diversification strategy may only work for relatively big or long-term investments. Alternatively, day traders often hold foreign exchange corresponding to a particular type of preferences.
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