Diversifying your Risk in the Stock Market

If you are going to invest in the stock market, the best way to prevent your portfolio from flopping is diversification. In investing, the phrase, “putting all of your eggs in one basket” refers to a simple portfolio of only one or two different stocks. This type of investing, no matter how strong a stock may look, is the fastest way to go bankrupt. Look no further than those who relied on the seemingly robust Enron, WorldCom, or Tyco stocks (though these are the extremes, they are meant to illustrate the unpredictability of even the seemingly safest stocks).

So how can you limit your risk and maintain a healthy presence in the market? Don’t fool yourself into thinking you’re the one who can make the big kill. Sure, you can put a huge investment into Nameless Software Company and be lucky enough for them to come out with the next big thing in computer technology. But if that company comes out with a new technology that mirrors the reception that Windows Vista received, you’re not going to like what happens to your investment. Spread your money around.

If you feel that the new software company looks like it has high potential, investigate it further and think about purchasing a moderate amount of its stock. In addition, look into an investment in news media, energy, retail, entertainment, or any other stock that you feel has a high potential for growth. Depending on how much money you are investing, to have at least a decent level of diversity, you want to be invested in at least five to ten different stocks. Also, try to keep a similar number of shares of each of your stocks. If you have 90 percent of your investment in one stock and the rest peppered across a few different investments, your attempts at diversity are effectively pointless.

Beyond simply diversifying your investment, you want to make sure that you research each stock before investing. Find out the history of its performance, the records of the company’s leaders, and even how it relates to current events. For example, today, it might be wise to invest in reputable alternative energy sources with a shift from oil, coal, and natural gas looming in the near future. Similarly, when a negative situation arises, such as the announcement of a product recall, steer away from that product’s producer.

Finally, to ensure that your risk is truly minimal, make sure you have a safety net in the form of a saving’s account, a CD, or a rich uncle. No matter how careful you are, there is always risk in investing in the stock market. Yet, if you maintain a diverse portfolio, do your research before buying, and maintain a safety net, you will be far more likely to see a net gain than a net loss.