Friday, March 6, 2015

Benefits of Diversification

Diversification isn't just to avoid the risk of a single company stock going bankrupt. It can also reduce the ups and downs of your portfolio.

Take a peek at the chart below. What it shows is what would have happened over the past 5 years to $1,000 invested in 5 different companies. The bold orange line, however, is what would have happened had you taken $1,000 and invested it evenly between the same 5 companies.

There are a few things to notice here.

First – over 5 years, the values ended up roughly around the same whether you chose to invest in a single stock, or in a diversified portfolio of the 5.

I purposefully picked stocks with similar performance over this time frame to make the main point, which is that even though you end up in roughly the same spot after 5 years, the diversified portfolio got there with less dramatic ups and downs than the individual components.

Lastly – notice that these 5 companies come from 3 different industries (Industrials, Energy, and Information Technology), so the fact they had very similar performance over the past 5 years isn't because they were in similar businesses.

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