When you were in school, you had to concentrate on your studies. When you began your career, you had to concentrate on your work. In fact, in just about every endeavor in life, concentration is essential for success. However, as an investor, you may find that you actually don’t want to concentrate too much.
That’s not to say you shouldn’t concentrate on your investment decisions — you should. But if you concentrate too much money in one investment, or one type of investment, you could run into problems.
Suppose, for example, that your portfolio is almost entirely devoted to growth stocks. During a good economy, growth stocks generally tend to do well; so if we’re enjoying a period of sustained growth, your portfolio might show some good returns. But if the economy slumps while you own only growth stocks, you could sustain losses that may take a long time from which to recover. On the other hand, if you over-concentrate on fixed-income investments, such as bonds, your principal value might increase when interest rates are falling (as interest rates and bond prices are inversely related), but when interest rates rise, your bond portfolio will likely lose principal value.
To help avoid the problems of over-concentration, it’s important to own a range of investments, which may include stocks, bonds, government securities and certificates of deposit (CDs). While this type of diversification cannot, by itself, guarantee a profit or protect against loss, it can help reduce the effects of volatility on your portfolio.
Of course, how you choose to allocate your assets will depend on a variety of factors, including the following:
- Your goals— Your ultimate objectives should help govern your investment strategy. If you are planning to retire early and then start a new business, you may need to invest more aggressively than, say, your neighbor, who wants to work as long as possible and then stay close to home, pursuing inexpensive hobbies.
- Your risk tolerance— Just as we all have different personalities, we have different tolerances for investment risk. If you can assume greater risk in exchange for potentially higher returns, you may be a more aggressive investor. Conversely, if you’re willing to take lower returns as a trade-off for greater protection of your principal, you’re probably a more conservative investor. However, to achieve your goals, you may consider moving outside your investment “comfort zone” from time to time.
- Your time horizon— Your stage of life will also affect your investment choices. If you are just starting your career, you can probably afford to invest more aggressively than if you are nearing retirement, at which time you may want to cut down on risks.
To build a diversified portfolio that reflects your goals, risk tolerance and time horizon, you may want to work with a professional financial advisor — someone who can assess your situation and recommend choices that are appropriate for your needs. By concentrating on a unified investment strategy — instead of over-concentrating on a specific type of investment — you can focus on where you want to go and what you need to do to get there.